Intervoice, Inc. F1Q09 (Quarter End 05/31/08) Earnings Call Transcript

| About: Intervoice Inc (INTV)

Intervoice, Inc. (INTV) F1Q09 Earnings Call July 9, 2008 5:00 PM ET


Craig E. Holmes - Executive Vice President and Chief Financial Officer

Robert Ritchey - Chief Executive Officer

Jim Milton – President and Chief Operating Officer

David W. Brandenburg - Chairman


Daniel Ives - Friedman, Billings, Ramsey & Co.

Shyam Patil - Raymond James

Peter Jacobson – Brean Murray, Carret & Co.

Tavis McCourt – Morgan, Keegan & Co.

Scott Sutherland - Wedbush Morgan Securities Inc.

Craig Nankervis - First Analysis Corp.


Welcome to the Intervoice fiscal 2009 Q1 earnings release conference call. (Operator Instructions) I would now like to turn the call over to Craig Holmes, Intervoice’s Chief Financial Officer.

Craig Holmes

Here with me in Dallas is David Brandenburg, our Chairman of the Board; Bob Ritchey, our Chief Executive Officer; and Jim Milton, our President and Chief Operating Officer.

Our earnings release issued today was prepared and approved by company management and reviewed and approved by our audit committee. During this call we will also discuss a second press release we issued today describing Bob’s retirement and Jim’s selection as CEO.

During our comments this afternoon we may make some forward-looking statements and factors that could cause results to be materially different from our expectations are detailed in the risks, uncertainties, and contingency sections of our SEC filings. We also encourage investors to reference those risk factors as well as the Safe Harbor disclosures in our earnings release we issued today.

Included in our press release are also preliminary GAAP basis financial statements which will be finalized and filed with the SEC and our 10-Q tomorrow. In addition, we have included schedules which show our revenues by product and by geography and a schedule which reconciles our non-GAAP disclosures to GAAP disclosures. We believe that certain adjustments are necessary to improve the comparability between reporting periods and we hope these additional schedules enhance the transparency and overall quality of our reported results.

The remainder of this call will follow this format. Bob will give his overview and comments. Jim will then follow with an update on our product sales and operating activities. I will discuss the company’s financial results. David will wrap up the call with his comments. After our prepared comments, we will open up the call to a brief question-and-answer period.

Now let me turn the call over to Bob Ritchey, our CEO.

Robert Ritchey

On today’s call I will address my pending retirement which we announced today plus cover the highlights of our Q1 results.

Regarding my retirement, as reported I plan to step down as CEO of Intervoice on August 31 of this year. The Board and I established a secession strategy approximately two and a half years ago and this action is the finalization of that plan. While I will relinquish my day-to-day duties to Jim Milton, I do plan to stay actively engaged with the company by continuing to serve on the Board of Directors.

My eight years at Intervoice have been a very rewarding experience for me as I have had the opportunity to work with some great people and companies. We have a team of highly skilled and dedicated employees and managers and an amazing list of customers; some of the biggest and best brands in the world. I feel fortunate to have had the opportunity to work in this exciting environment.

During this time our industry and company has experienced its set of challenges. We all can remember 9/11. That hit at a very tough time for Intervoice. The dot com bust and periods of economic and technological turmoil much like we are experiencing right now. However, through all the challenges we have been able to continuously reposition the company for future success. The journey has included moving from a proprietary hardware oriented company to a standards based software and services company. We consolidated our disparate products into a unified product architecture serving both our enterprise and network markets.

We strengthened our sales and marketing capabilities while maintaining our number one market share in IVR and have become a serious challenger in the unified messaging segment. Our acquisition of Edify and Nuasis also further strengthened the company for future success.

Over the next seven weeks I will complete the transition to Jim Milton as my successor in a seamless manner and assure that we continue to stay focused on the successful execution of our FY09 business plan.

I will talk more about the CEO transition in a minute but let’s now focus on our Q1 accomplishments.

Even in the midst of widespread economic turmoil we have been able to generate very good quarterly results. Our Q1 focus was on both negotiating the economic headwinds in our markets while assuring the ability to generate double-digit operating income. I am pleased to say that both of these business areas remain very positive. Our Contact Center and unified messaging markets remain very active and we see substantial short and long-term sales potential.

While clearly our customers are being cautious about their capital and operating expenses, the value of our solutions generally offset the expense risk and provide a compelling return on investment. Also, our non-GAAP operating margins have returned to double-digit levels. Specifically we achieved revenue of $51.5 million which is an 8% increase over Q1 of last year and non-GAAP operating income of $7.1 million which is a $5.4 million increase over Q1 of last year. In fact, this is the highest level of non-GAAP operating income percentages we have achieved since Q4 of 2005.

The $7.1 million translates into a 13.8% operating income percentage in relationship to our Q1 revenue. I am very pleased with these results. Following our cost overruns in certain projects during Q4 we focused the organization on understanding the issues associated with the overruns and taking corrective actions. These actions resulted in us rebalancing our R&D, GCS and sales expenses to more efficiently align with our current revenue and future growth opportunities.

Also associated with these actions we reduced our headcount by 26 positions and put in place other expense reduction plans. Craig will provide you more details associated with these cost reduction initiatives plus the overall improvement in adjusted gross margin to 56.4% that we achieved in Q1.

As I said at the end of Q4 I did not believe our Q4 gross margin and operating income results were indicative of our future capabilities. Regarding our bookings and backlog results, Q1 solutions bookings were $20 million. This follows a blowout Q4 solutions bookings of $39 million. Therefore it is not unusual to see lower Q1 bookings following such a strong year-end close.

Of our total solutions bookings the Americas market contributed 45% and the international market unit 55%. The bookings and revenue mix resulted in Q1 solutions backlog of $62 million or a 3% gain over Q1 of 2008. Our total backlog remains very strong including solutions, the maintenance and hosted solutions and we continue to have substantial leverage from our backlog to sustain future revenue growth.

Further during Q1 we completed the operational transition to Jim Milton by moving full accountability for product management and R&D under his leadership. We also announced the retirement of Mike Olson. Mike was our Senior Vice President of R&D and Chief Technology Officer and he effectively left the company on March 31 of this year. Mike was employed by Intervoice for 21 years and had made numerous contributions to the company in the area of product architecture, design and product delivery. Mike also has contributed to the company by participating in 29 patents either filed or awarded. Mike’s leadership and knowledge will be missed and we wish him the best in his future endeavors.

Jim is currently acting as the head of this department and with the assistance of Robbie Narayan. Robbie is the Vice President of Product Management and has been associated with the company for approximately two years. Robbie brings a strong background in high tech product design and development. This change in leadership had been contemplated for several quarters and the transition has been carefully managed.

In reflecting on Intervoice at this stage in our journey to be a software and services company we have come a long way. I believe our product architecture, based on pure IP technology, is the best in the business. Most of our competitors have developed hybrid products that blend their traditional proprietary technology with an IP wrapper. This type of design will not provide their customers the flexibility and future value they are expecting.

Also now that our unified platform has been successfully launched in both our market segments our focus has been on increasing value for our customers by expanding into the Contact Center with our newly announced contact portal which includes traditional IVR, the new IPCC (the product we acquired from Nuasis) and notification functionality. The addition also of value added applications into the wireless carrier markets like voice SMS, outbound notification, video store and forward and voice portal applications.

The other area of our business that has developed into a significant differentiator for the company is our consulting services capabilities or GCS as we call it. Both in the Contact Center and wireless carrier market we have improved our processes and delivery of high value applications while also improving our profit margin in this very specialized area of our business. Starting in Q1 we have been closely managing the cost of delivery in our GCS area by improving design to pricing formulas and aggressively managing our direct and subcontractor expenses.

However, there remains a careful balance between cost management and value driven customer satisfaction. Going forward I continue to like the prospects for Intervoice to grow our top line while managing our expense ratio consistent with double-digit bottom line performance. However, given the uncertainty of the macroeconomic environment we are very focused on maximizing our short-term bookings and backlog to position us for sustained double-digit growth in the future.

Therefore, I believe our Q2 revenue will be in the $52-54 million range. This revenue guidance provides for a significant year-over-year growth trend and will position us for continued growth in Q3 and Q4. I certainly believe better days are ahead for our company which will also translate to even better results for our company.

As for completing the CEO transition to Jim Milton, I am very confident in Jim’s ability to lead Intervoice into the future. Jim came to Intervoice with extensive sales, marketing and operations management experience. He has been a quick study of our industry and has essentially been leading the company’s day-to-day operations for the past 18 months. As this will be my last IR call as CEO of Intervoice I want to thank all of you for your support over the past eight years, or 32 quarters depending on how you count. I look forward to watching the company successfully challenge the current economic headwinds and continue the journey to lead our industry through product and service innovation and financial performance.

Now I will turn the call over to Jim Milton, our soon to be CEO.

Jim Milton

I am excited to be taking over the helm from Bob on September 1. In my 2.5 years at the company I have come to appreciate the great assets of Intervoice which include a very talented and innovative employee base, a large and loyal installed base of customers and a strong portfolio of products and services. It is my commitment to leverage this set of assets to deliver more value to our shareholders going forward.

Turning to our Q1 results while solutions bookings and revenue were not as robust as we would have liked solid execution of projects and a strong focus on cost control resulted in the best non-GAAP operating income performance in 13 quarters. Craig will go into more detail on the Q1 financial results, but it is clear that our focus on driving improved profitability has paid off.

Coming off a great solutions booking quarter in Q4, we experienced a relatively slow start to bookings during Q1. Additionally, some of our opportunities at financial services companies have been delayed. The good news is that these projects have not, for the most part, been cancelled or lost but delayed or broken up into multiple phases. That stated, I expect that our solutions bookings will drive an increase in backlog during Q2 based on our current pipeline of large deals, both network and enterprise, for the quarter.

Highlights for Q1 included another quarter of solid performance by our network channel. We closed four new network operators through Huawei and Ericsson including our first media exchange sale through Huawei and our first network operator in North America through Ericsson.

In the enterprise business Q1 was an important quarter for new product releases and announcements. Intervoice announced version 4 of our IP Contact Center Solution in March. This version of IPCC delivers seamless integration between our self-service and live agent solutions as well as features including enhanced security and new configuration tools enabling shorter configuration times.

In May we announced version 5 of Intervoice Voice Portal adding new features such as outbound IVR and support for Nuance 9 and IBM Web sphere voice server for speech recognition and text-to-speech. Nuance Verifier, an IBM Speaker Identity Verification for Voice Authentication are now supported.

In addition to addressing large enterprise needs for a highly scalable solution, IVP 5 is also now available in a highly cost effective, tightly integrated voice portal in a box or speech in a box configurations for small to mid size enterprises. Along with IVP 5 we also announced the new offering for multi-channel outbound notification called Advanced Notification Gateway or Intervoice ANG. ANG includes outbound SMS, email and voice alerts which enables enterprise or service providers to deliver real time notifications such as flight changes, transaction confirmations and emergency notifications.

The combination of IVP 5, IPCC 4 and ANG led to our announcement of the industry first Contact Portal unifying the functionalities of self-service to live agent capabilities as well as outbound IVR and proactive notifications. This fully integrated multi-channel suite of Contact Center Software Solutions delivers customer centric cost reduction by giving customers enhanced convenience and choice while simultaneously lowering costs through automation.

Several industry analysts have written positive articles or blogs about Intervoice Contact Portal. Yankee Group has publicly stated, “Intervoice has redefined the dynamic customer experience with Contact Portal. It is a unique end-to-end Contact Center Solution that starts with a customer. Unlike traditional telephony based solutions that focus on agents or expert resource productivity, components of the Contact Portal are focused on offering customers convenience and choice to maximize their experience.”

Contact Portal is also resonating with our customers. Per our press release issued on June 26, Dickinson Financial Corporation is the latest Intervoice customer to extend their Intervoice Self Service Solution to their live agents with the addition of Intervoice IPCC. Marvin [Shute], EVP of DFC stated, “We are happy to learn that Intervoice now offers an IP based Contact Center Solution to improve our operational efficiencies.”

We are aggressively taking this expanded portfolio to our customer base and as a result are seeing an expanded pipeline of opportunities. As I look forward to Q2 and beyond, we have streamlined the organization through the creation of two geographic business units combining the sales and consulting services organizations under the leadership of two general managers; Frank Sherlock and Andrea Holko. This results in more accountability for bookings, revenue and profitability in an organization that is better aligned with our customers. These sales and services teams will be focused on our core growth opportunities including: First, up selling our enterprise customers to speech self service applications and expanding into live agent automation with our Contact Portal Suite of Solutions. Second, providing IP messaging and network IVR applications and new and existing network operators directly and through our Huawei and Ericsson partnerships. Third, leveraging our partnerships with companies such as IBM and Clickbox to drive new opportunities. Fourth, expanding our international enterprise business through our recently added new channel partners in key growth markets. Fifth, increasing our subscription or annuity revenues through our hosted or maintenance service offerings.

Finally, we will continue to stay focused on aggressively managing our costs so that we continue to deliver solid and sustained profitability in the business. Now over to Craig Holmes who will discuss our Q1 financial results in more detail.

Craig Holmes

Let me start out by highlighting some quarterly financial results. Our revenues were within range. Our gross margins were better than expected. Operating margins were better than expected. Net income was better than expected. Cash flow better than expected. GAAP earnings of $0.08 per share. Non-GAAP earnings of $0.13 per share. Overall a very good quarter particularly considering the macroeconomic environment in which we are currently operating.

Now let me cover some of our detailed first quarter financial results. Recurring revenues are up $800,000 sequentially and $1.6 million from Q1 of last year. Our maintenance revenues grew 5% and our hosting solutions revenue grew almost 10% from prior year levels. Our recurring services revenues are highly visible and predictable revenues and we continue to be focused on growing this valuable revenue stream.

Our solutions sales include revenues from sales of our software as well as revenues we receive for consulting services and some third-party components. Total solutions revenues for the quarter were driven by new bookings as well as the conversion of our solutions backlog into revenues. Our Q1 solutions revenues of $23.9 million were down from the fourth quarter but up 10% from the first quarter of last year.

Our voice portal solutions revenues increased 6% sequentially and almost 12% from Q1 of last year. In addition we saw our messaging solutions revenues down quarter-over-quarter but up an impressive 19% from prior year levels. Both product lines are benefiting from our multi-year investment in new IP based product offerings.

During the quarter about 9% of our Q1 revenues came directly from projects included in our solutions sales pipeline at the beginning of the quarter. These include our book-and-ship revenues. These revenues totaled $4.5 million in the first quarter. At this point based on our bottom set forecast we currently expect our pipeline and book-and-ship revenues in Q2 to continue to run in the $4-6 million range.

The remainder of our Q1 revenues, or about 91% of our total revenues, came from our beginning period solutions backlog and backlog of services contracts. During the first quarter we converted about 30% of our beginning of period solutions backlog to revenues. Our bottom set forecast indicates we currently expect to see our Q2 conversion rate remain in the low 30% range.

During the first quarter we saw a nice recovery in our overall gross margins. Our Q1 non-GAAP gross margins increased from 51.9 to 56.4%. This increase was primarily attributable to improved margins related to the delivery of several large network implementations. As we discussed last year we expected margins to improve as we gained experience implementing our new next generation messaging solutions. Good project management and good project execution by our global consulting services organization combined with benefits from change orders and third-party cost reductions helped drive solutions gross margin improvements during the quarter.

Q1 non-GAAP R&D expenses were down $700,000 from the prior quarter primarily related to a reduction in contractor costs as we began to wind down some customer specific projects and the effect of the consolidation of departments from a management perspective. As Jim mentioned the R&D organization continues to support an aggressive product roadmap and several key products were launched during the quarter.

Our GAAP SG&A for Q1 was down about $300,000 from the prior quarter but non-GAAP SG&A was down almost $800,000. During the quarter we saw benefits from outstanding cash collection activities from both our sales and collections departments. We saw reduced medical insurance accruals and the positive settlement of a prior year state tax matter.

To sum it up, the entire Intervoice team aggressively worked to manage the departmental and project costs which enabled Intervoice to achieve the high profitability we reported.

The tax provision for the quarter and fiscal year is lower than normal statutory rates due primarily to our earnings mix across geographies and several small adjustments to prior year accruals. For example, we recorded tax benefits because the German government actually lowered corporate tax rates. As we show in our press release we recalculated our taxes based on a 34% estimated rate for non-GAAP purposes. We feel that this rate is a more normalized long-term rate given our operations in the various geographies where we do business today.

Now let me move on to the balance sheet and cash flow statement. Our cash balance was $52.7 million, up $14 million from the prior quarter. Our cash flow from operations was also up significantly from prior quarter levels. Many of our customer’s maintenance contracts renew at the beginning of the calendar year so we typically see strong cash flow from operations during the fourth and first quarters of our fiscal year.

DSO’s continue to run in a range I expect and accounts receivables reserves and bad debt are minimal. During Q1 we saw our inventory balance stay relatively flat and we spent about $1.5 million in capEx. We currently expect quarterly capEx to remaining that $1.5-2 million range for the next few quarters.

Now let me summarize our Q2 guidance. As Bob mentioned we expect Q2 revenues to be in the $51-54 million range. Our Q2 non-GAAP gross margins are expected to run in the 54-56% range. Our gross margin estimates are based on our bottoms up analysis our project management teams have completed based on their review of current projects.

At this point we expect GAAP and non-GAAP R&D and SG&A costs to be up about $1 million in Q2. These cost increases result from annual raises which were effective June 1 as well as other G&A costs returning to normal run rate levels.

Full amortization will continue to run around $650,000 per quarter and investment income should continue to run and come in at about $350,000. Total stock compensation expense in Q1 was $1.2 million and going forward we expect Q2 stock compensation expense to be about $1.3 million including the incremental charges associated with accelerating the vesting and extending the exercise period on Bob’s options as described in the 8K we filed earlier.

In Q1 we incurred approximately $1.6 million of restructuring costs and in Q2 we expect to incur an additional $1.1 million related to Bob’s severance agreement and other restructuring activities.

To sum it up our Board and management team has invested in strategic and operational initiatives which have strengthened our market position and significantly improved our profitability. We have made good progress the last few quarters and continue to strive for consistent, profitable growth.

Finally, as always I would like to thank all of our shareholders and analysts for their continued support. I would like to thank the team here at Intervoice for helping us to achieve such impressive profitability.

Now let me turn the call over to David, our Chairman, for closing remarks.

David Brandenburg

A quick summary of highlights from Q1 that really stuck with me are, one, and Q1 revenue was up 8% year-over-year. Gross margin and operating margins are in great shape and better than expected. Cash flow was great and better than expected. Q1 GAAP and non-GAAP EPS was better than expected. Also, our cash balance plus our Dallas real estate is equal to about $2.00 per share.

Looking forward to Q2 and beyond I expect revenue growth in the high single-digits in the short-term and double-digit in the long-term. Expect adjusted operating income to be in double-digits going forward and we expect backlog to grow in Q2.

Today our stock price closed at $5.35 per share, adjusted for cash and real estate it is about $3.35 per share. Using any valuation method I can think of I believe Intervoice is undervalued.

I’d like to thank Bob for his eight years of service to Intervoice and good luck in retirement and as a Board member. I look forward to continuing to work with him on the Board. Speaking for myself and the rest of the Board of Directors I would also like to congratulate Jim Milton who will be taking over as CEO of Intervoice September 1. The Board is looking forward to working closely with Jim and we have great confidence in his ability to lead us into the future.

Again, thank you all and good investing.

Robert Ritchey

That actually concludes our prepared comments.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Daniel Ives - Friedman, Billings, Ramsey & Co.

Daniel Ives - Friedman, Billings, Ramsey & Co.

Let’s say this three months and the last three months you did a great job on cost control. Can you just give us an anecdotal discussion as to the selling environment, customers, maybe even month-by-month throughout the quarter? Did it get worse or better? Something to that extent would be helpful.

Jim Milton

As I mentioned in our prepared remarks obviously we had, I think I said a great but probably the more appropriate term would have been “blow out” quarter in the fourth quarter on solutions bookings. If you recall we delivered in the $39 million of solutions bookings range so I think some of our weaker performance in Q1 was certainly based upon the great performance we had in Q4. So that caused us to have a relatively slow start to the quarter as I mentioned.

Additionally, not any surprise to anybody on this line I’m sure, is the financial services sector was weak but as I also said in my prepared remarks the good news is we are not seeing those projects go away. We are seeing them getting broken up into smaller pieces or phases as those various financial services institutions decide to, if you will, defer some of their capital spending but get started on driving thankfully in our systems we deliver pretty good ROI so financial services segment is obviously weak but not completely gone to sleep because we are still seeing business from that sector.

In general throughout the quarter I would say it got stronger as the quarter went on. Some of that again based upon our great finish to last quarter and I was optimistic enough as we headed into this quarter and where we are in this quarter at present to state that I expect our backlog will grow coming out of the second quarter. By and large I would say I am fairly optimistic about the environment in general. Some of that is due to the nature of what we sell.

Thankfully, especially on the IVR Voice Portal side, we can drive tremendous cost savings to companies and we have seen implementations of our technology result in ROI’s of six months. Certainly less than a year in some cases. If you just do the math the average call handled by an IVR or self service system is $1.00 or less. The average call by a live agent is typically $7-12 per call. You can see if you can deflect calls from going to live agents the return is astronomical.

Additionally, with IPCC now as part of our portfolio and extending into what we call Contact Portal our value prop has improved even more so. So I feel pretty good about the environment in general. Obviously it would be great if there was a lot more capital spending going on but nonetheless we are performing well.

Daniel Ives - Friedman, Billings, Ramsey & Co.

So, outside of financials on the Call Center side how would you characterize that environment in terms of spending in non-financials?

Jim Milton

I think if you go through by industry segment the telecommunications industry remains strong. Thankfully we have a very strong footprint in the telecommunications segment both on the IP messaging side of the house as well as on the Voice Portal or IVR side of the house. We continue to see spending in the telecommunications segment.

We have seen good results in segments like utilities and the Federal, state and local government I would say are the segments that seem to be doing well for us. Some of that is based upon the footprint we already have in those industry segments but again I think our value prop is resonating well in those segments in general are doing okay.


Your next question comes from Shyam Patil - Raymond James.

Shyam Patil - Raymond James

Could you talk about the environment in North America versus the rest of the world? Is there a difference in the demand trends for purchasing you are seeing? Particularly in your enterprise business, how would you characterize demand in this segment for touch tone systems versus speech?

Jim Milton

First of all I think you would have heard in Craig’s results and his comments as well as in the press release some good news that we probably didn’t highlight enough was the fact that our Voice Portal revenues are up year-over-year by about 12% in the solutions venue category. We are actually seeing a nice improvement in that category of our business in general. That has happened both in North America and international although I will say obviously the opportunity internationally for us in particular is stronger.

Part of the reason for that isn’t necessarily just the buying trends of companies in North America it is the fact that IVR’s and Voice Portals are by and large under-penetrated in other countries around the world. Part of the reason for that, in effect a lot of the IVR and Voice Portal business in North America particularly in large companies is somewhat of a replacement business.

There aren’t as many green field opportunities although we are seeing some of those. But elsewhere in the world, particularly as the cost of labor increases the IVR and Voice Portal value proposition also increases because in other words the cost of live agents, for example, increases with the labor rates rising in various countries.

By and large I think the market growth, for Intervoice specifically, the market growth is greater outside of the United States and secondly our market share is less generally speaking outside of the United States. I see that as being the stronger growth driver at least on the enterprise side of our business.

Shyam Patil - Raymond James

Could you talk about on the enterprise IVR side if you have seen customers buy more touch tone ports or if you have seen the percent of ports that are speech enabled accelerate in this environment?

Jim Milton

We are actually getting a mix of the two and in fact we have been quite successful in displacing some of our competitors in the last several quarters and this is fairly characteristic of the trend we are seeing. When we do that frequently it is a touch-tone to touch tone or DTMF to DTMF migration phase I.

Phase II, those same customers tend to start to add speech applications so they actually have a mixed environment of both speech and touch-tone. Some applications lend themselves to touch-tone but the ones that are more complex that have more menu offerings, for example, really lend themselves to speech.

By and large we are starting to see that increased penetration of where speech is able to address areas that heretofore touch-tone could not address. Particularly, by the way, entirely new applications that are entirely automated that aren’t just moving from touch tone to speech but in fact are brand new applications that formerly had to be handled by customer care agents.

So, yes we are seeing an increase in penetration but I wouldn’t call it an exponential increase. It is probably fairly consistent with what we have seen in the past year.


Your next question comes from Peter Jacobson – Brean Murray, Carret & Co.

Peter Jacobson – Brean Murray, Carret & Co.

On the SG&A you talked about I think it being up $1 million on cap G&A. Were you referring to a sequential change or year-over-year?

Craig Holmes

It was a sequential increase in our operating expenses which would include R&D and SG&A. That total increase would be about $1 million in the quarter. A lot of that is driven by annual raises.

Peter Jacobson – Brean Murray, Carret & Co.

Last quarter you talked about having some learning curve issues associated with I believe the media exchange product and now that you have fixed some of the issues relative to various projects where do you feel you are as far as the experience level and the ability to avoid project disappointments going forward?

Craig Holmes

I think what we referenced last year we did have a couple projects related to new media exchange implementations where we did incur incremental costs above what we had hoped. I’d say we didn’t have that experience this quarter as you can tell from our results. In fact literally across the board what we saw is our projects coming in at or even below budgeted levels. Here again, hats off to the project implementation and project management teams.

I’d say that what we referred to last quarter was something that we eloquently call the economies of experience around here. We have coined that term lately as we have embarked on some of these new product implementations. I think we are gaining economies of experience. We are getting more experience. We certainly don’t make the same mistakes twice. I think we have seen specific implementation examples where we had Phase I, Phase II, Phase III and multiple big network implementations we saw literally significant sequential improvements in the margins associated with those different phases.

We are getting better. We are learning as we go along. We have trended back towards our historical gross margin and solution margin levels and we would like to think that we are going to continue to do so going forward. The answer to your question is yes. We hope those learning difficulties are behind us.

Peter Jacobson – Brean Murray, Carret & Co.

Finally on being at the low end of the revenue guidance range as opposed to the middle or high end, is that grossly impacted by new book-and-ship or backlog conversion?

Craig Holmes

What we saw is if you look at our results, $51.5 compared to the middle of our range - $1.5 million miss, I think that is also the difference that we saw between what we achieved from a book-and-ship level, what we took out in a book-and-ship revenue level compared to where we expect it going into the quarter. We did see a fall off in our book-and-ship revenues. I think some of that is probably tied back to the softness we saw in the financial services industry.

We do have some vertical resellers as well as some horizontal resellers. We saw revenues from those resellers decline during the quarter. I think as we are able to track the larger deals and more significant deals what we are seeing is some of those deals are pushed out. They haven’t gone away. We expect that to be true with some of the smaller deals that we can’t see as clearly through our channel partners.

Peter Jacobson – Brean Murray, Carret & Co.

The mid end of the range or the high end in the current quarter would you say the key variable is book-and-ship?

Craig Holmes

What we incorporated into our guidance was a book-and-ship estimate of $5 million and that is literally the middle of the range of what we see today as we see it here based on our tracking of current opportunities.

Peter Jacobson – Brean Murray, Carret & Co.

That is the key variable you would say in terms of how that might vary?

Craig Holmes

That is one of the key variables. There is always a couple of key variables in any given quarter. We do have a significant amount of visibility going into the quarter. Our ability to convert revenues out of our backlog is somewhat dependent on us but it is also even more dependent on our customers.

Sometimes their priorities may change. Those priorities change in ways that accelerate our ability to convert backlog but also can change ways that would not allow us to convert the deals we would have expected to convert early in the quarter. We monitor those situations very, very closely. I’d say at this point in time we do believe we will be able to achieve revenues within the range that we guided.


Your next question comes from Tavis McCourt – Morgan, Keegan & Co.

Tavis McCourt – Morgan, Keegan & Co.

You mentioned a win with Ericsson and a North America carrier that seemed maybe a little more significant than you gave it credit for. Was this a competitive win? Was it a competitor that is now dual sourcing messaging or can you give us some more details on your opportunities to expand that particular carrier?

Jim Milton

Yes. I have to be a little bit careful on how much I say because I don’t have approval to talk about the end user in great detail. I will say the deal size wasn’t huge. Probably the reason why I didn’t give it a lot more visibility but around $250,000. It was for SMS application. Yes, it was a competitive win. I think most significantly beyond the size of the deal is the fact that we are now working with the North American market unit of Ericsson on multiple opportunities.

SMS or what is called SMSC is a repeatable and pretty rapidly deployable solution. It doesn’t have, certainly compared to large IP messaging deployments, is measured in the matter of sometimes weeks rather than months so your ability to convert those opportunities to revenue sooner is significant and they are very repeatable.

I would say the fact we are now penetrating another market unit of Ericsson where historically we have been successful in probably 9 or so of the 22 market units of Ericsson around the world this is the biggest or second biggest of their market units. That is significant, you are right, in itself.

Tavis McCourt – Morgan, Keegan & Co.

Craig can you give us an update on the large European contract you had margin issues with last year. Can you give us an update of where you are on the revenue end of that? How much was recognized this quarter and how much has lapsed? Will it get recognized in this quarter or the next few quarters?

Craig Holmes

We had a large, unnamed network operator in Europe. The revenues that we recognized last year were primarily associated with Phase I of that project. We are currently involved in the second phase which is almost equal size and the revenues we are recognizing this year on a quarterly basis continue to be in that same range as last year.

We are getting around $3 million a quarter of revenues associated with that project implementation. The margins on those revenues are better. I’d say they are not great yet but they are definitely better than where we were a year ago. We are definitely heading in the right direction.

Tavis McCourt – Morgan, Keegan & Co.

Is there a phase III or is phase II the final phase?

Craig Holmes

We hope there is a phase III. All we have in the backlog is the phase II that we are working on today.

Tavis McCourt – Morgan, Keegan & Co.

The work down continues until after the fiscal year or does it complete in this coming quarter?

Craig Holmes

It does. It continues through the fiscal year and a lot of the work will be done in the second and third quarter but some of that work will continue into the fourth quarter and even the first quarter of next year.

Tavis McCourt – Morgan, Keegan & Co.

I don’t have the benefit of the press release but were there any stock buy backs in the quarter? David, I agree with you on the value of the stock. Why not be more aggressive here especially given the cash flow generation?

Bob Ritchey

No, we did not purchase any stock during the quarter. Obviously we continue to evaluate the use of our cash here and we will not take any action and we will continue to look at that and analyze the opportunities.


Your next question comes from Scott Sutherland - Wedbush Morgan Securities Inc.

Scott Sutherland - Wedbush Morgan Securities Inc.

What percentage of your bookings were enterprise versus network? The second question I have is how much revenue is cash based? Third, if you look through the remainder of your deals or follow-on deals with the lower margin, early network deals, do you see any other depressed margin issues coming up from those deals or is this pretty much a thing of the past in terms of the margin?

Bob Ritchey

We’re working on all three of those here for a minute, Scott. Probably maybe starting with the easiest one with relative to the success rate of media exchange going forward and the margins are now unfolding. Obviously we sold a couple of lead projects there that had no margin or very thin margin and we saw some of the results of that coming out of backlog in Q4 but for the most part that is all behind us.

Certainly Jim is working really hard with our team to really start selling the value of what we have here. It is always difficult to get started with a new product like that and you have to take your early shots. But we are certainly in a much better position now and the goal is to obviously get this product really contributing very strongly to our gross margin and I think we are well on our way towards accomplishing that now with all the new projects that we are bringing in.

Jim Milton

I will just add that we are also continuing to focus on margin improvements associated with [inaudible] deployments. For example, as Craig mentioned the term he coined economies of experience. What that really means is our services people having done a few deployments have those under their belts. It gets easier to do another one that looks the same or similar. Obviously in many contractor fixed prices based upon competitive dynamics in the market place so it really comes down to the variable of how quickly you can implement and how efficiently you implement. That is what we mean by economies of experience.

Additionally, there are other things we are looking at. For example, we have some of our partners that we are providing third-party hardware through today which obviously is at a lower margin than if you were in more of a pure play software model. How do we move to a more software centric model through some of those channel partners which will drive our margins up quite nicely? The last area is ensuring that our third-party costs associated with those deployments are a lot smaller by renegotiating suppliers, having in some cases dual suppliers where we perhaps only had one. There are lots of areas for us to continue to improve margins even in an environment that is competitive from a pricing perspective. All those things are moving upstream.

I won’t guarantee that there won’t be a project here and there where we have a situation where we have cost overruns. That is the nature of the business. I don’t want to set any expectations this will never occur. However, I think we have a much better handle and by and large when you take the larger, the macro multiple deals, you will continue to see and we expect to continue to see good margin performance.

Your question on the breakdown on bookings, I think was your first question, network versus enterprise in the first quarter. I’m not sure we have the exact breakdown analysis yet. Probably around 50/50. I know our backlog year-over-year has grown more in the Voice Portal part of our business than the network part of our business but I think in the first quarter our bookings would have been fairly close to even. I know you are going to quote me on that but I don’t have the exact percentage for you.

Craig Holmes

Let me give you another data point relative to bookings and backlog. If we look at our backlog components today and we look at the growth in our backlog year-over-year our Voice Portal backlog is actually up about 19% from prior year levels. A lot of the growth we have seen this year was driven by incremental sales of our Voice Portal products. I think the last question you asked had to do with cash basis revenues. We have about $2 to $2.5 million of cash based revenues this quarter. That is about half what we had last quarter.

We do sell our solutions and services through some resellers that are somewhat thinly capitalized that we conservatively and appropriately treat on a cash basis. Also we do deliver our solutions and services to some customers that are located in countries that would require us to treat them on a cash basis. Cash based revenues this quarter are about one-half of what they were last quarter and those cash basis revenues were split fairly evenly between solutions and services revenues.


Your next question comes from Craig Nankervis - First Analysis Corp.

Craig Nankervis - First Analysis Corp.

In the February quarter you probably had four press releases that announced deals north of $4 million or something like that and here in the May quarter we had I believe no press releases for large deals. I wonder if you could comment on what is at work here in the financial services sector, breaking things up into components and so deal size, do you attribute this all to the financial services story? Or just is there a change in buying patterns in general and you are just seeing a trend towards a lot more smaller deals? Maybe if we can start there.

Jim Milton

First of all, we had three deals that we announced over $4 million in the fourth quarter which was a lot more than usual. That was a very good quarter as I mentioned earlier. $39 million in solutions bookings. We had none in Q1. I don’t think that is atypical that you would get some lumpiness in those deals. First of all I wouldn’t read too much into that relative to a trend because you might see if I went back over several quarters this is not inconsistent.

Although three is fairly significant. At least since I’ve been here I can’t think of a quarter where we had three deals over $4 million in a single deal. We did announce, actually, the fourth release you are referring to was an aggregation release where we announced three IPCC deals that totaled around $3 million. That was what I would call a momentum release. As was written, by the way, not just for you on the shareholder and analyst side but also for our customers to show we are having momentum with the IPCC products which in fact we are.

I wouldn’t read anything into that. I will say, however, that as I meant around the financial services comments I made in my prepared remarks we do have a few financial services deals we have been working on in the pipeline that have been split into phases.

For example, we will only announce a deal size in terms of the purchase order we received for that deal. Not necessarily the total project value or the expected project value if you aggregated all the phases together. In other words I get $500,000 now. I might get $2 million next quarter and $3 million the quarter after. That looks like $5.5 million. We wouldn’t announce that as a $5.5 million deal.

I think we are seeing some of that. That doesn’t particularly trouble me because as long as I get that $5.5 million in the example I just gave it is still a good thing. It just means it is not done as a one-shot deal.

Craig Nankervis - First Analysis Corp.

Can you tell me where you are on selling via Huawei in China itself? Is something close to happening? What is the progress there?

Jim Milton

I don’t want to go too far into my answer here and reveal proprietary information to them and us. I will say, as you do know, all of our sales with Huawei have been international. International meaning outside of China. That is essentially where the business unit, if you will, that we signed our agreement with. There have been changes within Huawei that you may have read about. They have spun out their applications and support division into a wholly owned subsidiary. This is the division we have been working with quite successfully. We are feeling very good about their future plans for driving more value added services as they call it that we are a big part of.

We are fully spec’d into their SAP systems, almost looking like a Huawei part number. That has been a lot of heavy lifting I might add by our people within the company to get to a level of essentially productizing to the point where they include like a part number. All of our business in our pipeline is still internationally based.

However, you would be disappointed if we weren’t working aggressively to get into their domestic business as well. Quite candidly I’m not disappointed we haven’t been in their domestic business because I think cutting our teeth with Huawei internationally has been good for us because the price dynamics of the Chinese domestic market are much more aggressive than elsewhere.

I think we are better positioned now that we have got actually a working model now with Huawei and as I mentioned we successfully closed our first media exchange deal with Huawei last quarter outside of China but nonetheless that is allowing us to penetrate and drive up the deal sizes.

Craig Nankervis - First Analysis Corp.

Craig as we think about the August quarter would you expect messaging revenue to be up sequentially or do you still expect pretty strong Voice Portal business like you saw here in the May quarter?

Craig Holmes

I would expect both of our markets to contribute to our growth. I think if I was to speculate on one side of the equation versus the other it would probably be messaging and international just a little bit. But they are both contributing and as Jim mentioned from a bookings perspective both markets contributed this past quarter and we expect revenues for both markets to improve going forward.


This concludes the question-and-answer session for today’s call.

Craig Holmes

On behalf of the team here at Intervoice I’d like to thank everybody for joining us this evening. Thank you and good night.

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