EasyLink Services International Corporation F3Q08 (Qtr End 4/30/08) Earnings Call Transcript

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 |  About: EasyLink Services International Corporation (ESIC)
by: SA Transcripts

EasyLink Services International Corporation (NASDAQ:ESIC)

F3Q08 Earnings Call

June 18, 2008 10:00 am ET

Executives

 

Emily Hanan - Investor Relations Group

Thomas J. Stallings - Chief Executive Officer

Glen E. Shipley - Chief Financial Officer

Analysts

Jon Hickman - MDB Capital

[Steve Richman] - Unidentified Firm

[Michael Kohr] - Unidentified Firm

Operator

 

Welcome to EasyLink Services International Corporation third quarter fiscal 2008 earnings conference call. (Operator Instructions) It is now my pleasure to turn the conference over to Emily Hanan of the Investor Relations Group.

Emily Hanan

 

With us today from management are Thomas J. Stallings, CEO, and Glen Shipley, CFO, of EasyLink Services International Corporation.

Before we get started, I would like to remind listeners of some key points.

First, during this conference call, including the question-and-answer session, management may make forward-looking statements regarding future events and/or future financial performance of EasyLink Services International Corporation. You are cautioned that any such forward-looking statements are not guarantees of future performance and involved risks and uncertainties and that actual results may differ materially from those contemplated by such forward-looking statements.

I refer you to the documents that EasyLink Services International Corporation files from time to time with the Securities and Exchange Commission, particularly the company's annual report on Form 10-K for the fiscal year ended July 31, 2007 filed with the SEC on October 23, 2007, including the risk factor discussion in Item 1A of that report and the risk factor discussion in Part II, Item 1A of our subsequent quarter report on Form 10-Q. These documents contain and identify important factors that could cause actual results to differ materially from those contained in our projections.

EasyLink Services International Corporation undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events, or changes in future operating results.

Second, if you do not have a copy of the earnings release, you may access it through the company's website, www.EasyLink.com, under the About EasyLink and Investor Information tabs.

At this time I'd like to turn the call over to Thomas J. Stallings. Tom, please go ahead.

Thomas J. Stallings

 

Thank you for joining us for our fiscal third quarter earnings call.

You will remember last quarter we talked about this being a year of growth and integration following our recent merger with EasyLink Services. The team and I are very pleased to report that this has been another quarter during which we have made great strides in building a pipeline that supports our aggressive growth plans and working through the final phases of our business integration. This is now the second full quarter of reporting following our merger and the results are clearly on par with our expectations for the year.

We would like to reiterate the metrics that we believe best illustrate our performance, which are revenue, gross margin, operating income and adjusted EBITDA. In each of these categories our results are consistent with the strong numbers we reported last quarter, once again showing that our team has remained focused on the integration process and new growth initiatives.

Glen will discuss our financial results in greater detail, but here are some highlights:

Total revenue for the quarter was $23.6 million and $68.2 million for the 9-month period.

Our combined gross profit margins improved to a solid 71.1% from the previous quarter, when we reported 70.2%.

Operating income was $4.52 million for the quarter and $12.38 million for the 9-month period.

Adjusted EBITDA for the quarter was $7.2 million, and that takes us to $19.7 million for the 9-month period.

The story behind our numbers has not changed dramatically from our second quarter. The solid revenue and gross margins reflect the ability of our dedicated team and its commitment to meet the year end projections of $90 million in revenue and $22 to $24 million in EBITDA. We feel secure with these numbers and are confident that this objective is obtainable.

During the quarter we announced our vision for the company in terms of its financial goals. We plan to achieve $250 million in revenue by the end of our fiscal 2010 year. The past two quarters have been a great launching pad for us to meet this objective, and we've been pleased with our results so far.

We have benefited from the smooth transition and integration process between ICC and EasyLink. As a result, the team has been able to focus its energies on new opportunities as they pertain to both organic expansion and acquisition prospects. The result is an improved company with clearly defined goals and strategies as well as the manpower to help ensure we deliver on our intentions.

As a result of the progress we have made, I am pleased to note that Gartner, a leading industry analyst firm, recently included EasyLink in its report entitled, "Magic Quadrant for Integration Service Providers”. The analyst report defines and depicts leading vendors in the integration service providers category and measures 14 companies against particular criteria. We believe the inclusion in the Gartner report is validation that the market recognizes our growing role and presence as a key player in this space.

Likewise, our recent accomplishments led to MDB Capital Group initiating coverage of EasyLink beginning on June 2 with a very comprehensive report written by Jon Hickman.

On the operational front, we have several achievements I'd like to mention.

First, John Mecke, our Vice President of Global Product Management and EDI Managed Services, was appointed chair of X12's Marketing Advisory Group. X12 is the cross-industry standard designed by the American National Standards Institute to support any business function in any industry, and it was designed to provide a single standard with a common uniform language for electronic communications. And we're proud to have John join that group.

Most recently we expanded our sales team with the appointment of Scott Ferguson. As was announced yesterday in the press release, Scott will become or has become the Vice President for Sales in Asia Pacific. Scott brings more than 25 years experience in the information technology industry and we are pleased to have him join our team as part of our efforts toward continuing to expand our international footprint. He has significant experience driving growth and new business across Southeast Asia and the Pacific. We think he has the capability to help us penetrate the international market, in particular the Asia Pacific region.

In addition to our operational achievements this quarter, there have also been many exciting business developments I'd like to speak about. We have succeeded in consolidating our quality programs from both our legacy companies into one that addresses the business objectives of EasyLink Services International. We also made several upgrades to our technology. We upgraded our domestic fax platform to deliver traffic at higher speed with improved quality at a lower cost per minute. Additionally, we upgraded our EDI environment in London with state of the art equipment to deliver improved performance. These modifications will ensure we are providing the highest quality service for our customers.

I am pleased to mention we negotiated new telecom contracts with our providers to effectively reduce expense by approximately $1 million a year. Additionally, we significantly expanded our customer base during this quarter, much the same as we reported last quarter. We secured several noteworthy accounts that I'd like to specifically mention by name: California Pizza, Brookstone, Red Hat Software, Quintiles, Prudential Insurance, Union Bank of California, and Micron Technologies. These new accounts along with others will generate more than $1 million in recurring revenue. Our team continues to produce strong results, and we're pleased to report another solid quarter that will help us meet our year end goal.

At the international level, we made notable progress securing contracts and building revenue through our continued support of our telex solutions. Specifically, in May, McCall signed a contract for a $90,000 telex IP gateway, Italy Cablegram billed out over $33,000 in April and $44,000 in May, and the Venezuela Network billed out $46,000 of new revenue in May. Our accomplishments in these areas prove our commitment to global expansion. It also demonstrates the efforts of our team, which we continue to strengthen.

We continue to expand our customer base even further. We currently have over 15,000 clients worldwide across a wide range of industries. Many of our companies are household names and have an established market presence. We see value in the percentage of our business that comes from outside the United States, currently accounting for approximately 25% of our total business. Going forward, it is one of our goals to increase this percentage dramatically.

At this point I'm going to hand over the call to Glen, who will review our financial results in detail. After that, I will return to review the company's strategy and vision, and then we'll take some calls from our investors.

Glen E. Shipley

 

I would like to review the financial results for EasyLink's third quarter ended April 30, 2008 and the corresponding 9-month period in more detail.

As previously noted, revenue for the third quarter ended at approximately $23.6 million, with revenue for the 9month period of approximately $68.2 million. While we will provide you some year-over-year comparisons, we continue to stress that we do not view these comparisons as meaningful to our shareholders as a result of the magnitude of the EasyLink acquisition.

Last fiscal year's revenue for the third quarter was $5.4 million and for the nine months of fiscal 2007, revenue was $16.5 million. The operations that generated these 2007 revenues are now part of our Supply Chain Messaging segment.

And, on a segment reporting basis, the results for the third quarter are as follows:

Revenue for Supply Chain Messaging, which includes all electronic data interchange or EDI services and our telex services, was $12.3 million, which represented 52% of total consolidated revenue and produced a 74.8% gross margin.

Revenue from our On-Demand Messaging, which includes faxing, production messaging, document capturing, management and other e-mail services, was $11.3 million, which represented 48% of total consolidated revenue and delivered a 68.1% gross margin.

Our combined gross profit margin for the quarter held strong at 71.6%.

Revenue for the 9-month period in Supply Chain Messaging segment was $36.2 million or 53% of total revenue, with a gross margin of 74.2%.

Revenue for the 9-month period for the On-Demand Messaging segment was $32 million, representing 47% of total revenue and delivered a gross margin of 67.5%, with a combined gross margin for the 9-month period of 71.1%.

On a quarter-over-quarter basis, third quarter revenue of $23.6 million was essentially flat compared to the second quarter's revenue of $23.65 million. We do notice some minor quarter-over-quarter seasonality in revenue, particularly in our Supply Chain Messaging segment, and in particular the retail vertical.

Our gross margins, however, were up from the second quarter's 70.8% to 71.6% in the third quarter, with operating income for the third quarter at $4.25 million, up $300,000 from the second quarter's $4.49 million.

We continue not to emphasize GAAP net income as a metric by which shareholders should measure our success, but we note that GAAP income for the third quarter was $6.89 million as compared to GAAP income of $3.27 million for the second quarter and had a fully diluted income per share of $0.17 in the third quarter as compared to $0.10 in the second quarter.

In the third quarter we recorded $1.09 million in non-cash interest expense from amortization of our beneficial conversion feature as compared to $2.37 million in our second quarter. We also booked a net tax benefit of $4.42 million in the third quarter from the release of a portion of our tax loss carryforward reserve. This compared to $1.02 million in the second quarter. We do not expect to release any more of this reserve in fiscal 2008 as we anticipate the amounts released to date will cover expected tax income for the fiscal year.

We continue to encourage shareholders to consider adjusted EBITDA as a better measure of our performance as this figure filters out many of our adjustments, such as the beneficial conversion feature. Adjusted EBITDA for the third quarter was $7.2 million and $19.7 million for the 9-month period, comparing this to fiscal 2007 third quarter of $1.4 million of EBITDA and $4.3 million for the 9-month period.

As noted in the second quarter earnings call, our second quarter EBITDA included a one-time reversal of $768,000 in expenses which, if taken into account for comparative purposes, second quarter adjusted EBITDA would have been $6.9 million.

Turning to the balance sheet, we ended the third quarter with $27.2 million in cash, total current assets of $45.8 million, and total current liabilities of $17.5 million. Net debt was $42.8 million.

Before we open the floor for questions, I'd like to turn it back over to Tom for some final comments.

Thomas J. Stallings

To reiterate what I mentioned earlier in the call, we believe we are on track for continued financial growth as we expand our business both organically and through acquisitions. Our team is particularly focused on expanding our international footprint while remaining committed to providing superior solutions and services to our customers worldwide.

In achieving these goals, we hope to build momentum for growth to ensure we produce results for the company and its shareholders. We have succeeded in securing a significant number of new accounts with established notable companies and plan to continue work toward expanding our list of customers, both domestically and internationally.

As mentioned in the beginning of this call, the four metrics we remain focused on are revenue, operating income, gross margin and EBITDA.

I would like to also emphasize that we remain interested and very active in pursuing acquisition opportunities. We realize that our ability to execute acquisitions going forward and integrate new businesses will be a critical component of our overall results.

We also believe that we have already exhibited our ability to successfully identify good targets and execute an efficient integration process. This remains the strategy going forward, and we hope you will look to our track record in evaluating our capabilities.

Overall, we are pleased with the strong results of the quarter. We believe we are on the path to achieve our revenue objective of $250 million by 2010. As we have mentioned in the past, we expect fiscal 2008 to be a very strong year for EasyLink. Taking into account this quarter's results, paired with our performance through Q2, we believe we are positioned to consistently deliver solid results and continue to meet our goals as we move forward.

Thank you for your attention and interest. At this point, Operator, we would like to take questions.

Questions-and-Answer Session

 

Operator

 

(Operator Instructions) Your first question comes from Jon Hickman - MDB Capital.

Jon Hickman - MDB Capital

 

I was just wondering, I think I missed a number. You said that you expect revenues by 2010 of what?

Thomas J. Stallings

$250 million.

 

Jon Hickman - MDB Capital

$250 million in your fiscal 2010 number.

Thomas J. Stallings

Yes.

Jon Hickman - MDB Capital

So that would be two years from now or a year and a half, whatever.

Thomas J. Stallings

Right.

Jon Hickman - MDB Capital

Then let me ask you a question about the gross margin line. It seems like you're generating pretty good improvement there, quarter to quarter. Could you give us some expectation of how, you know, is that going to level off or what the improvement might be going forward?

Glen E. Shipley

 

I actually think we are probably going to be fairly level around the 70% combined margins as we go forward. It will fluctuate slightly up and down by a few percentage points depending on the mix of the sale and the revenue recorded. It's obvious that you get a little bit higher margin out of the EDI world as compared to the fax world as a result of provisioning requirements, particularly the provisioning of phone numbers, but the margins are not going to dramatically improve.

Jon Hickman - MDB Capital

Okay, so around 70%. Okay, and then could you just walk through a little bit of this tax benefit? So you release some of your NOLs to cover your expected tax?

Glen E. Shipley

Right. We have a fully reserved tax asset of 100% for all of our NOL carryforwards. We have released through this quarter and last quarter the amount that we think will be necessary to cover our taxable income as to be reported for the current fiscal year ended.

We will have, however, obviously more reserve which may be released in subsequent periods, of course, depending on our results.

Jon Hickman - MDB Capital

And your total NOLs are how much now?

Glen E. Shipley

Currently about $70 million, which translates down into a tax asset - which, again, is fully reserved of about $35 million, which includes a few other items besides loss carryforwards.

Jon Hickman - MDB Capital

Okay, so you don't expect anything in the coming quarter, but in the next fiscal year you might use that asset to offset tax liabilities going forward?

Glen E. Shipley

Correct. Under the generally accepted accounting principals, we eventually face the issue - as long as we keep making money, a certain amount of tax basis - releasing the entire thing once.

Jon Hickman - MDB Capital

And then could you comment on what you're seeing as - one more question, please - kind of an expected growth rate in the two segments?

Thomas J. Stallings

Well, I think we've stated a couple of times we expect organic growth across the board to be in the range of 10% to 15%. Obviously, back to your first question, that won't get you to $250 million by 2010. Our intent is to combine organic growth in the mid-teens with acquisitions during the period.

Operator

Your next question comes from [Steve Richman].

Steve Richman

 

Yes, could you explain why the marketplace doesn't reward this company with a higher stock price? It seems that your growth has been phenomenonal and your EBITDA earnings are phenomenonal, but I have a feeling that the public is not rewarding the company with the kind of stock price that you would expect from a company that has showed this kind of results. Do you have any thoughts or comments on that?

Thomas J. Stallings

We couldn't agree with you more. We do have some thoughts.

I think we were all surprised by the negative reaction from the market on our financial structure or our debt structure with York Capital, which created an overhang of about 25 million shares. And I think that causes people to go ahead and to look at sort of a fully diluted number in excess of 50 million shares, although, if the financial structure were to play itself out over the next four years, I doubt that all those shares would be converted. So that's kind of the worst-case scenario that people have a tendency to take a look at, at least from the dilution or possible dilution point of view.

And also I think that we are just now engaging in making ourselves more public, having more people become aware of the company. We're spending more time in Investor Relations and having conference calls of this nature, so we expect to see some benefit from that as well.

Steve Richman

One thing I do notice. You had on your statement approximately $2 million of interest expense, and I assume that, from what you said, most of that's going for the conversion feature. Is that correct?

Thomas J. Stallings

Well, there are two types of interest expense being recorded by the company currently. One of them is the actual cash interest that we pay quarterly on the outstanding debt. The other one is the so-called beneficial conversion feature, which is a noncash interest expense which was originally created on close of the deal due to the structure of the pricing of the converts as compared to the market at that time.

For those who have forgotten perhaps, we had to record about a $20 million reserve that's just going to be run through our P&L as interest expense over the life of the loan. So we always like to make a distinction between the two because one of them is a book entry; one of them is actual cash.

Steve Richman

But see, I don't think the public really understands that, and I think that's a part of the drag on the company's price, the fact that a significant amount of the interest is going to that conversion factor. And if you look at diluted shares, the $0.17 per share diluted, you really have to take out the interest that's being paid on that because it's like double counting it.

Thomas J. Stallings

Well, we have to completely agree. It's a very difficult issue to explain. It's one we continue to attack. But that is, again, why we keep insisting or suggesting that people look at the EBITDA and not the GAAP earnings.

Steve Richman

Yeah, I think that's not happening. If you looked at Investor Daily, for example, they portray the earnings as diluted as $0.05 a share, which is sort of ridiculous. The way I calculate it, if you took the interest out, you would really be at somewhere around $0.09 or $0.10 a share.

Thomas J. Stallings

Well, you won't get an argument from us. But we keep trying to - all we can do is keep trying to educate people.

Steve Richman

It's not an equitable way to look at it because you can't say diluted shares and then put in the extra 24,000 or whatever - million, I'm sorry, 24 million - and then also keep the interest in because if the conversion took place, you wouldn't have the interest anymore.

Thomas J. Stallings

You're exactly right.

Steve Richman

So the marketplace is really - because I think they're not really understanding this, most people do not understand this transaction. And I think just because of that, the stock price is being held lower than it really should be.

I mean, by any standard of multiple based on what this company's really earning, this thing should be much higher than $3.50.

Thomas J. Stallings

Again, we couldn't agree with you more. But you've hit the key points right on the head. Those are the issues that we discuss and spend a great deal of time with on a regular basis.

Steve Richman

Is there any way of highlighting that next time you do a statement where you could say in your highlights that there was X amount of interest expense and, you know, just explain this, that it's not right to count dilution and interest at the same time? It's either one or the other. Does management have that prerogative to state that?

Thomas J. Stallings

Well, I think we do state it. In the call we just distinguished the amounts that were noncash from cash.

Steve Richman

Yes, but I don't think you highlighted this. I don't think you explained it the way we're discussing it now, that, in effect, it's like double counting against the company by putting interest in and putting diluted shares in.

Thomas J. Stallings

No, you're absolutely right. I think the challenge, of course, is to maintain reasonable practices and not over communicate the issue, but communicate it effectively. And I would agree that we're challenged to do that. I suspect that we could put more effort into how it's worded in the press release that goes with the earnings announcements. We could probably do a little bit better job of discussing it there.

I guess we also think that the most effective way to communicate it, unfortunately, is not on a broad base, but the most effective way to communicate it is in conversations like this as opposed to trying - it's a very difficult subject to write into a paragraph, and I guess that's why we've so much steered away from it.

But it's challenging. We readily admit its challenging. It's challenging to overcome. And we certainly think that the company has not gotten its just reward for the value of the transaction and the performance since the transaction.

Steve Richman

I believe that as time goes on it will, though.

Thomas J. Stallings

We certainly hope so, yes.

Operator

And we do have one final question from [Michael Kohr].

Michael Kohr

 

You've announced that you have a buyback of 1 million shares some time this year. If you're going to be making acquisitions or possible acquisitions, could that buyback wind up being cancelled or have you started any of the buyback of the shares?

Thomas J. Stallings

We have made limited purchases of our shares. The announced buyback has significant flexibility. It would only be used as we see fit, and in that case, it would be when the shares were trading down, when the stock was trading down in the mid-$2 range. We thought that was a very good use of our cash.

As the price has regained some momentum and gone in the other direction, it really is - we would prefer not to spend our money there, but rather hold it for possible acquisitions, etc.

So it's up to us to manage and balance that, we believe.

Michael Kohr

In addition to that, York Capital has a major financial position within the company. Is it conceivable that if they activated all the warrants and conversions that they have they can actually take over control of the company?

Thomas J. Stallings

No, they cannot. Per terms of the agreement, they cannot own more than 9.9% at any one time, therefore they would have to liquidate their holdings as they convert, which was, quite frankly, an intentional mechanism put into the agreement as the plan was to convert and sell into the marketplace.

Glen E. Shipley

Under the current financing arrangement, their intention was never to be a majority holder.

Michael Kohr

Okay, but do they have a Board of Directors seat?

Glen E. Shipley

No.

Thomas J. Stallings

No, they do not.

Michael Kohr

Okay. Are they going to be the participant for loaning you additional money in regard to all sorts of acquisitions?

Thomas J. Stallings

They are supportive of the platform and the company moving forward for additional acquisitions. Whether or not they actually put additional funds into the company is an open question at this point.

Operator

There are no further questions at this time. I would like to turn the conference back over to Tom Stallings for any additional or closing remarks.

Thomas J. Stallings

Thank you, ma'am. Thank you, everybody, for your continued interest and support of the company. It's greatly appreciated. I speak on behalf of everyone at EasyLink in saying we look forward to working together toward the achievement of our shared future goals.

Thanks again for your time and your attention today.

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