SoundBite's Poor Quarter: Bump in Road, or Edge of Cliff?

It looks like I’ll be eating my first dose of humble pie since I started PeakStocks.com about 7 months ago. In a business where if you get slightly over 50% of your picks right, you attain rock star status, it looks like we’ll be adding SoundBite to the “losing” side of the scorecard, at least for now.

SoundBite Communications (SDBT), a leading provider of on-demand customer contact solutions, reported its fiscal 1st quarter 2008 earnings on Wednesday May 7th after the market closed, and to say they were bad would probably not serve the word “bad” properly.

Not only did SoundBite miss their own guidance and estimates for the first quarter, but they also LOWERED guidance for Q2/2008, AND full-year 2008, only 3 months after they had raised that same guidance.

So is it time to sell SoundBite and cut our losses? Maybe…

What follows is a brief summary of SoundBite’s earnings announcement and conference call, with my solemn thoughts at the end.

Look for a full report on their latest quarter and analyst conference call highlights in a few weeks after they release their latest 10-Q filing and I have a chance to parse the data fully.

Hit Me With Some Numbers

Lower Guidance Already?

Here are some of SoundBite’s earnings lowlights (growth from previous year’s 1Q/analyst’s estimates where applicable):

• Quarterly sales of $10.6 million (up 21% from prior year/vs. $10.86 million projected)
• GAAP quarterly loss of (-$1.5 million), or a loss of (-$0.10) per diluted share (down from a (-$.86 million), or (-$1.37) per diluted share, loss in the prior year)
• Non-GAAP quarterly income of (-$636,000) (down from a (-$31,000) loss in the prior year)
• Non-GAAP loss of (-$0.04) earnings per share (up from a (-$.05) loss in the prior year/ vs. $.00 projected)
• Gross margin shrunk to 61.7% (down from 63.9% from prior year, and 66.6% last quarter)

My Take: Yuck…I couldn’t even try to dress these numbers up if I wanted to. I guess the only good news is that sales actually did grow 21%, but does it really matter when losses grew even faster?

In addition, SoundBite is facing more intense competition, and it’s showing up in their lowered margins. They are having to lower their prices to be competitive with the other players in their space, more so than they expected.

Other Business Highlights (Lowlights)

Lowers Guidance, Free Cash Flow Improves

• For the second quarter of 2008, SoundBite currently projects GAAP revenues in the range of $11.2 million to $11.8 million and gross margin in the range of 61% to 63%. This compares to analysts expectations of $12.33 million (about a 6.7% decline taking the midline).
• For the second quarter of 2008, the projection for Non-GAAP operating loss is in the range of $400,000 to $900,000.
• For the full year 2008, SoundBite lowered their GAAP revenues to a range of $47.0 million to $49.0 million from the previous range of $53.3 million to $55.3 million, and analysts expectations of $53.47 million (about a 10% decline!)
• For all of 2008, SoundBite projects GAAP gross margin percentage to be in the range of 61.0%-64.0%, from a previous range of 62%-65%.
• For all of 2008, SoundBite is estimating a non-GAAP operating loss of $100,000 to $1.6 million.
• In Q1 SoundBite had 184 active clients, an increase of 10% vs. 167 in the prior quarter.
• Existing clients accounted for 99% of total revenue, while new clients accounted for 1%.
• Top 20 clients accounted for 78% of total revenues.
• Cash flow for Q1 was $1.5 million
• CAPEX: $631,000
• FCF: $869,000 (First Free cash flow positive quarter!)

My Take: Well, SoundBite WAS cash flow positive this quarter and free cash flow positive for the first time ever as a public company…that has to count for something right?

Don’t bet on it!

This is obviously not what I expected or could foresee coming! Especially in light of last quarter’s beat and raise earnings announcement where everything in the business seemed to be humming along quite nicely…

There’s nothing I can say except I was flat our wrong on this one.

Conference Call Highlights

URS Patent Litigation Continues, Despite Crappiness, Management Still “Excited”

The following are the highlights from SoundBite’s analyst conference call:

• URS Patent Litigation Update: There seems to be 2 separate items with regards to the URS patent litigation claims. Management wasn’t entirely clear on the call, but I believe it breaks down thusly:

Part 1: First off, SoundBite believes they are still on track for a May expedited trial date for the previously mentioned URS case where SoundBite sued URS for tortious interference during their IPO, and they believe they will be successful in this suit. They have completed the discovery process with a number of depositions being taken and they are merely waiting for a trial date, which they believe will take place this month.

Part 2: In addition to this first suit, it seems that SoundBite is now a part of another suit AGAINST them on the part of URS.

According to management on the conference call, on May 1st, 2008, URS filed a complaint in federal court in Minnesota, looking to retract its statement of non-liability, from the aforementioned case.

In the new complaint, URS asserts a claim for material misrepresentation, alleging that it filed the original statement of non-liability after relying on what it characterizes as “false representations” from SoundBite concerning its non-infringement of URS’s issued patents.

URS has also asserted a claim that SoundBite’s on demand AVM products infringe on one of URS’s existing patents. SoundBite’s response to URS’s claim is due on June 25th, 2008.

This appears to be a separate claim than the one that they are going to trial on in May.

My Take: Yet another wrinkle in the SoundBite vs. URS matter. I am going to have to talk to management to clarify this exactly, and make sure that I got my story straight, but I believe these are 2 separate lawsuits, one brought about by SoundBite against URS for interfering with their IPO, and one brought about by URS against SoundBite withdrawing their original non-infringement claim that took SoundBite off the hook in the original suit.

Confused yet? I’ll make sure to get to the bottom of this.

• Patent Infringement Suit Cost: The above guidance does not include approximately $1.7 million in legal expenses for the URS patent litigation suit, that is expected to total about $2.5 million by the end of the year.

• Overall Economy’s Affect on Business: During the 1st quarter, SoundBite had a number of collections clients utilize their service less than was originally anticipated, and they believe that some of this is the result of the sub-prime mess that is affecting many markets, and decreased usage as a result.

The CEO further stated that because of the current credit climate, collections agencies are having a harder time collecting debt, and therefore, are taking a more conservative approach to using SoundBite’s services.

He reiterated that their business typically has some seasonality built in. The first quarter is typically lower in sales on a sequential basis from the 4th quarter of the preceding year, and then sales rise in each subsequent quarter, and they expect this year to be no different.

When talking to an analyst, the CEO explained that they never said their business was countercyclical, but the CEO explained that because people are losing their jobs, houses, etc., they are unable to pay anything, and that includes debt, so debt collection agencies are scaling back their usage of SoundBite as a result…

My Take: I am mystified by these comments!

I want to make sure I got this right: SoundBite is a countercyclical company (at least that’s what we were led to believe when first investing in the company), BUT not if the economy goes down too much, then its just like every other business? I am not too happy about this change in tune at all.

• First and Third Party Collections: When asked about the relationship of the 1st party (companies that use SoundBite to collect their own debt, retain customers, etc.) to 3rd party (companies that use SoundBite ON BEHALF of other companies) and why their revenue fell short, the CEO stated that what they are seeing and didn’t anticipate was that the 1st party guys are taking longer to test and evaluate their campaigns before deciding to ramp up and spend more on them.

He said that they seem to be more cautious and it takes a month or more to get the data back and analyze it and then move on it.

Furthermore, when the analyst asked if they had seen some of these 1st party customers pull back or back out of their testing and contracts, the CEO said no, that none of them have done so, which is why they are so bullish on the continued growth for them (SoundBite) and the sector, but that they cannot predict with certainty when these accounts will convert.

The CEO then kept stating how “excited” they are about their future growth prospects, and gave various “examples”.

My Take: Huh? So you are excited because it looks like more and more 1st party clients are signing up to use your stuff, but as of yet, they are slow to commit and use SoundBite’s offerings, but nonetheless, the CEO is EXCITED about their future prospects?

Oh, and I might want to remind everyone, that SoundBite did just LOWER 2nd quarter guidance and full-year guidance pretty substantially….but overall, I’m really excited too!

• The CEO on Forward Guidance: Moving forward SoundBite believes it prudent to lower their guidance in light of the abovementioned factors for the following reasons:

1. The current economic climate and softness in the collections industry are likely to continue through year’s end
2. Second, they are seeing pricing pressure from competitors using both hosted and on-premise solutions
3. Third, because in the last year they have focused their products and marketing on 1st party clients

While the resulting revenue stream is greater in this segment, ramping up sales and securing contracts are more difficult to predict, and garner.

Further, the CEO noted that in these times, companies are laying off employees and reengineering their processes rather than focusing on new initiatives like SoundBite’s services, even though in theory, they fully understand the potential cost savings and benefits to their organization.

My Take: While any lowered guidance is never good, some are better than others. This was not the good kind, and the reasoning behind the lowering of the guidance makes sense, but I still think that SoundBite should have seen this coming.

Bottom Line

SoundBite is on Notice!

I’ve been pounding the table so hard, and for so long for SoundBite, that my hand hurts!

I pride myself on doing diligent and persistent research on all the companies that I follow. This includes talking to management on a frequent basis, constantly revisiting my investment thesis for any changes, and monitoring any news that comes out about a company and how it might affect us…

But as we can see, sometimes you are surprised by totally unforeseen factors or circumstances, and nothing you could have done would have changed the outcome, short of inside information.

All I can say is that I was flat wrong about SoundBite, at least for right now.

SoundBite is in the penalty box, and instead of just issuing a sell on the shares, I’m going to take my time, and get some more information on exactly what is going on.

That includes trying to get an interview with the CEO/CFO that I will post on the site, where hopefully, we can get some clarification on what has transpired and not jump to any rash decisions.

After all, in my original investment thesis for SoundBite, one of the risk factors was any kind of change in the business and the lumpiness in earnings from quarter to quarter.

Well, we’ve just hit a proverbial “lump” all right…

I’ve given SoundBite the benefit of the doubt by not delisting them yet to a “HOLD” or “SELL” but the company is officially on notice and the clock starts ticking now.

Shares of SoundBite might fall more from here…it might get painful out there, so if you want to sell now and ask questions later, I won’t blame you, but one bad quarter should never be enough to sell a solid company that hit a bump in the road, or was that a lump?

Along those same lines, because SoundBite’s shares have already been beaten up badly from their initial IPO price, it’s entirely possible that the shares actually won’t drop much more from here because SoundBite is already trading at or near their cash on hand of about $2.30 per share, and their Book Value of about $3.00 per share.

Either way, I want to wait this one out, and see if this was just a temporary interruption of SoundBite’s business or something more serious, before pulling the plug.

I understand that it’s management’s job to curtail unreasonable expectations, and run a business, so I’m willing to give them the benefit of the doubt.

SoundBite gets one quarter to straighten things out, then it’s Hasta La Vista Baby!

Comments

[Dira]

So in what would appear to be an optimal environment for debt collection agencies SDBT is having difficulty getting prospects to use their product.

This sounds to me like an umbrella salesman having difficulty selling his product in monsoon season.

[investorslive]

Off a cliff for now

Here's what I'm watching: www.investorslive.com/.../

[Mr L]

Sounds like the CEO is totally out of confidence in his company. I´ll wait till Chris talks to him. Let me suggest you ( Chris) to have a meeting face to face, better than a phone call. There are some "visual" signs you have to monitor and comunicate to us all. Thanks for your sincerity.

[JTucc]

We all make bad calls at times. No worries, Chris. Just keep thinking and keep writing. Lets learn and move on...Thank you for the reports.