Altigen Communications - Riding The Coattails Of Teams, Microsoft's Fastest Growing Application

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About: Altigen Communications, Inc. (ATGN), Includes: CXDO
by: The Calculated Investor
Summary

Altigen successfully changed their business model to a cloud-based, recurring revenue one.

Financial results have turned positive and momentum is building as the new business model gains traction.

Altigen is making great inroads with their solutions for Microsoft Teams and leveraging this relationship to upsell other applications.

Number of customers have almost quadrupled over the last 4 years and there is still a huge potential market remaining.

Share price recently pulled back and is consolidating before a potential next spike upward.

Investment Thesis

After I posted my article on Crexendo (OTCQX:CXDO), SA contributor, Sergio Heiber, referred me to another player in the fast expanding, new age telephony space, Altigen Communications (OTCQB:ATGN). After performing my due diligence, I decided to initiate a position in ATGN, too.

Altigen has been in the doldrums over the last decade, but recently changed their business model to a more sustainable, lucrative cloud-based one with recurring revenues. The new business model turned financials around and the company is now cash flow positive and the share price is reflecting this growth.

The company has been very successful in offering their solutions to Microsoft Team customers and upselling other applications. Teams is Microsoft's fastest growing application in the history of Microsoft and now has more than 13M active daily users. Altigen has only started to scratch the surface with the Teams opportunity and still has a long runway ahead. Their recent acquisition of 2,000 cloud subscribers from Workspace will boost their transition even faster.

Company Profile

Altigen Communications is a Microsoft Cloud Solutions provider of so-called premise and cloud-based IP-PBX and Contact Center solutions. Their Cloud PBX and Multi-channel Contact Center solutions integrate with Skype for Business and Office 365. Microsoft Teams, which has been released more recently, is part of Office 365 and includes the Skype for Business online capabilities that's only available for Microsoft as a hosted solution. The company recently changed their business model from mainly hardware to software based phone systems and providing cloud unified communications. This new recurring revenue business model is turning the company financials around from losing money to becoming cash flow positive.

Altigen's integrated IP applications suite provides their customers with a complete business communications solution, including voicemail, contact center, unified messaging, automatic call distribution, call recording, call activity reporting, and mobility solutions. These integrated solutions reduce complexity, eliminates capital expenditure and lowers the total cost of ownership versus on premises deployments of Skype for Business.

Altigen's customers are primarily end-users, resellers and distributors. They have distribution agreements with Altisys Communications and Synnex Corporation and a reseller agreement with Fiserv Solutions in North America. These 3 companies collectively represented approximately 30% of total net revenue for the three and six months ended March 31, 2019.

Altigen seems to have a number of nagging litigation cases against it, including one from 2016 where CTI Communications, a former reseller, alleged misappropriation of trade secrets, breach of contract, civil conspiracy and tortious interference. The company recorded a litigation expense of $604K, a receivable in the amount of $557K, and a payable of $433K in the fourth quarter of fiscal 2018 in connection with this matter. On February 1, 2019, Altigen was served with a cross-complaint filed by Intellitalk, Inc., an active reseller, that alleges interference with prospective economic advantage and unfair competition. Altigen responded to this complaint by filing a motion to dismiss the complaint on March 21, 2019. The Company has not recorded any liability with respect to this litigation as of March 31, 2019.

In 2010, Altigen deregistered its common stock with the U.S. Securities and Exchange Commission, delisted from the NASDAQ and listed its common stock on the OTCQX marketplace under the symbol ATGN. The company has a market cap of about $27M. Now that the company is doing financially better, management is trying to become more shareholder friendly and recently posted an Investor Presentation on their website. The company's restrictive so-called Preferred Stock Rights Agreement also expired on May 7, 2019. On the most recent earnings conference call, management referred to this Agreement as a "Poison Pill" that prohibited individual institutional ownership of more than 15% of AltiGen shares. The expiration of the Agreement allows larger shareholders to increase their ownership of AltiGen stock.

The company is based in Milpitas, CA and also has an office in London, UK.

Management

At the end of September 2018, Altigen had approximately 46 full-time employees, including 25 in research and development and support, 11 in sales and marketing, 3 in operations, and 7 in finance and administration.

The leadership team consists of the following members:

Jeremiah Fleming, Chief Executive Officer as well as President and Chairman of the Board of Directors - Mr. Fleming has been with Altigen since April 2007. Mr. Fleming has more than 25 years of experience in the software and communications industries and has a background in sales, marketing and business development. Before joining Altigen, Mr. Fleming was at Interactive Intelligence, Inc. where he served in an executive management capacity.

David Tang, Chief Operations Officer - Mr. Tang joined Altigen in 2011 to help develop and launch Altigen's unified mobile convergence strategy into the service provider market. Prior to joining Altigen, Mr. Tang was Chief Operating Officer and Vice President of Global Marketing at VoSKY Technologies where he spearheaded product strategy, led strategic business development, and built global distribution channels in North America, Latin America, Europe and Asia Pacific. He was also Vice President of Sales & Marketing for Anta Systems and served in strategic positions under the Leadership Development Program at SBC Communications (now AT&T).

Mike Plumer, Vice President of Sales - Mr. Plumer joined Altigen in 1996, serving in numerous positions of increasing management responsibility, ultimately being promoted to Vice President of Sales in 2000.

Shirley Sun, Vice President of Research and Development - Prior to her current role, Ms. Sun was the Director of IP Telephony for Altigen. She has also held management positions at 3Com Corp and was the cofounder and Engineering Manager for Centrum Communications, Inc. Ms. Sun has also held technical positions Novell and Vitalink Communications.

Paul Fullman, Vice President Skype for Business Solutions - Mr. Fullman joined Altigen in 2011 to head up business operations in EMEA. Mr. Fullman has a technical background with a number of Microsoft Specialist Qualifications. Prior to joining Altigen, he held a number of positions at Datasharp UK Ltd.

Philip M. McDermott, member of the Board of Directors - Mr. McDermott has served as a member of the Board of Directors since 2014. From June 1999 to May 2017, Mr. McDermott served as Altigen's Chief Financial Officer. Prior to Altigen, Mr. McDermott's served at 3Com Corporation as Director of Finance America Sales, as Vice President of Finance, Operations, and Administration for Chipcom Corporation and as Chief Financial Officer at David Systems Inc.

Keith A. Midkiff, member of the Board of Directors - Mr. Midkiff is a Partner and Chief Financial Officer of Pacific Rim Constructors. He previously served as Chief Financial Officer at Angie's List. He also held a number of senior financial positions at Interactive Intelligence, Inc. and Software Artistry Inc.

Ken Epps, member of the Board of Directors - Mr. Epps has extensive experience in telecom, healthcare, SaaS and Cloud technologies, and is currently the co-founder, President and CEO of AGNITY HealthCare. Prior to that, Mr. Epps was CEO of U4EA Technologies, CEO of BayPackets and held senior leadership positions at Williams Communications and AT&T.

Simon S. Chouldjian, member of the Board of Directors - Mr. Chouldjian is an independent investor and was the Vice President of Hardware Engineering at Altigen prior to his retirement in April 2015. Before joining Altigen, Mr. Chouldjian was the founder and Vice President of Engineering of Luxcom, Inc. Mr. Chouldjian also held management and project leadership positions at Hewlett Packard Corporation and TRW, Inc.

A Google search of the leadership team members and the past companies where they served, did not reveal any skeletons in their closets.

As of September 30, 2018, Mr. Fleming owned 15% of outstanding shares in the company.

Financials

Between 2008 and 2016, revenues have been declining from $19M to $8M, but over the last couple of years, revenues have been trending upward to $10M in 2018. The change in business model had a lot to do with this reversal and total recurring revenue as of the end of the Q319 was 86% of overall revenues and management targets 100% recurring revenues.

Gross profit margins for the last quarter was a healthy 80.6%, although it's lower compared to 81.7% in the preceding quarter and compared to 83.9% in the comparable period last year.

Earnings per share have been climbing from a loss of $0.04 in 2016 to positive earnings of $0.02 in 2017 and $0.43 in 2018. The oversized earnings for 2018 does include an $8.7M benefit from income taxes, though.

At the end of the third quarter of 2019, the company had $3.9M in cash and cash equivalence and a revolving line of credit of $524K.

The following graphic from the company's investor presentation summarizes some of their performance metrics.

Source: Altigen Investor Presentation dated June 2019

The graphic indicates that the company has been performing well since 2015 with the number of customers almost quadrupling to 576 and revenue per customer and subscriber steadily increasing, too.

Market Opportunity and Competition

According to Microsoft, their Teams application is the fastest growing application in the history of Microsoft and now have more than 13M active daily users. Microsoft also announced that they have more than 160M commercial Office 365 users which means 147M of those users can potentially deploy Teams.

Management indicated that they currently compete with Internet protocol and Internet protocol-enabled telecommunications systems, including Avaya Inc., Mitel Networks Corporation, and Cisco Systems, Inc., as well as hosted PBX service providers like 8X8, Ring Central, Inc., and Jive Software, Inc. Despite having some deep pocket competitors, management is confident that they have the following competitive advantages:

  • Fully managed hosted service offering;

  • Skype for Business UC Feature set powered by Microsoft;

  • Rapid service delivery;

  • End-to-end deployment, management and support;

  • Ability to reduce communications costs;

  • Full featured IP-PBX; and

  • Integrated multimedia contact center

Management also mentioned that they don't think any of their competitors on the contact center side offer direct routing for Teams. So, Altigen is able to deliver the Phone Service and then upsell their applications to add value. Altigen's solutions for Microsoft Teams are also deployed in Microsoft Azure that is almost a requirement to do business with Microsoft.

The company has filed several U.S. patent applications relating to various aspects of their client and server software, mixed-media communications and computer telephony. As of September 30, 2018, they have been issued 20 patents. These patents should help the company defend and grow its market share.

Forecast and Conclusions

Based on the financial results since 2016, I developed the following summary and forecast for FY19 (all number in thousands, except EPS and share count).

2016

2017

2018

6M19

F2019

Net Revenue

Hosted Services

$ 1,807

$ 3,206

$ 5,001

$ 3,004

$ 6,008

Service Support Programs

$ 3,871

$ 3,555

$ 3,186

$ 1,480

$ 2,960

Software

$ 1,786

$ 1,126

$ 1,611

$ 664

$ 1,328

Professional Services and Other

$ 967

$ 501

$ 204

$ 171

$ 342

Total Net Revenue

$ 8,431

$ 8,388

$ 10,002

$ 5,319

$ 10,638

Cost of Revenue

Hosted Services

$ 468

$ 1,160

$ 1,613

$ 913

$ 1,826

Software

$ 16

$ 24

$ 54

$ 24

$ 48

Professional Services and Other

$ 967

$ 86

$ (22)

$ 3

$ 6

Total Cost of Revenue

$ 1,451

$ 1,270

$ 1,645

$ 940

$ 1,880

Gross Profit

$ 6,980

$ 7,118

$ 8,357

$ 4,379

$ 8,758

Operating Expenses

Research and Development

$ 2,898

$ 2,847

$ 2,830

$ 1,260

$ 2,520

Sales and Marketing

$ 2,211

$ 1,988

$ 2,149

$ 1,040

$ 2,080

General and Administrative

$ 2,135

$ 1,824

$ 1,625

$ 1,045

$ 2,090

Litigation

$ 568

$ 70

$ 604

$ 12

$ 12

Total Operating Expenses

$ 7,813

$ 6,730

$ 7,209

$ 3,358

$ 6,702

Income/Loss from Operations

$ (833)

$ 388

$ 1,148

$ 1,021

$ 2,056

Interest and Other (Expense) income, Net

Interest and Other income, Net

$ 4

$ 9

$ 18

$ 19

$ 38

Interest Expense

$ (13)

$ (16)

$ (19)

$ (10)

$ (20)

Total Interest and Other (Expense) income, Net

$ (9)

$ (7)

$ (1)

$ 9

$ 18

Income/Loss Before Income Taxes

$ (842)

$ 381

$ 1,147

$ 1,030

$ 2,074

Benefit from (Provision for) Income Taxes

$ 6

$ (3)

$ 8,692

$ 16

$ 32

Net Income/Loss

$ (836)

$ 378

$ 9,839

$ 1,014

$ 2,042

-9.91%

4.51%

98.37%

19.07%

19.20%

Net Income/Loss per Share

Basic

$ (0.04)

$ 0.02

$ 0.43

$ 0.04

$ 0.09

Diluted

$ (0.04)

$ 0.02

$ 0.40

$ 0.04

$ 0.08

Shares used to compute net income/loss per share

Basic

22,799

22,799

22,820

22,854

22,854

Diluted

22,799

23,555

24,767

25,364

25,364

Management did not provide guidance for the rest of the year, so my forecast for the full year assumes that revenues and expenses will be similar to that of the first 6 months. Based on this forecast, EPS should be around $0.08 and at a current share price of about $1.2, the forward PE is 15. This seems to indicate that the company is undervalued based on their recurring revenue business model that is beginning to bear fruit as well as the huge Microsoft Teams opportunity. The following graphic from the company's investor presentation compares metrics with competitors and also indicates that the share price is undervalued.

Source: Altigen Investor Presentation dated June 2019

In a press release on August 6, 2019, Altigen announced that it acquired "all of the rights to the customer relationships of WorkSpace Communications, LLC", including 2,000 cloud subscribers, which they plan to migrate to its hosted Microsoft platforms. According to the press release, the "transaction is valued at 1.6 times the annual revenues for each WorkSpace cloud customer transitioned to Altigen, which is expected to be accretive to Altigen's current revenue multiple and net income." This is a big deal for Altigen and further supports their transition to provide solutions to Microsoft Team customers.

The following chart shows the ATGN share price performance over the last 5 years.

Source: Yahoo Finance

The chart indicates that the share price is already up by about 1,000% over this time frame as investors realize the potential for the company. Despite the potential risks of litigation and competition, I also believe that the company will greatly benefit financially from the Microsoft Teams opportunity, especially with the recent acquisition of the Workspace customers and that the share price still has a long runway ahead.

Disclosure: I am/we are long ATGN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.