Lyris, Inc. F4Q08 (Qtr End 06/30/08) Earnings Call Transcript

| About: Lyris, Inc. (LYRI)

Lyris, Inc. (OTCQB:LYRI) F4Q08 Earnings Call September 17, 2008 11:00 AM ET

Executives

Richard McDonald – Director, Investor Relations

Luis Rivera – CEO

Heidi Mackintosh – VP and CFO

Analysts

[Mado Kadolle] – FertileMind Capital

William Martin – Raging Capital

Unidentified Analyst – FertileMind Capital

Operator

Welcome to today’s Lyris fourth quarter and fiscal end year 2008 earnings conference call. (Operator Instructions) I’d now like to turn the call over to Richard McDonald, the company’s Director of Investor Relations.

Richard McDonald

With me today are Luis Rivera, our Chief Executive Officer; and Heidi Mackintosh, Vice President and Chief Financial Officer.

Before, I turn the call over to Luis, it should be noted that during the course of today’s conference call and the question-and-answer session that follows, we may make projections or other forward-looking statements that are subject to the safe harbor provisions of the Securities laws regarding future events or financial performance of the Company. We caution you that these statements are only predictions and that actual results may differ materially.

We also alert you to the risks that we disclose in the documents that we follow with the Securities and Exchange Commission, such as our annual and quarterly reports on Form 10-K and 10-Q. We do not undertake any obligation to update or correct any forward looking statements.

Luis Rivera

During the quarter, we continue to generate increased adoption of our new platform, Lyris HQ, and execute on our sales and marketing initiatives to increase both our market presence and market share. At the same, as has been the case for the past several quarters, our financial results for the quarter reflect both the transition of our selling efforts to focus on Lyris HQ and the investments we have made in sales, marketing, and product development.

Revenues in the quarter were essentially flat with those of the fourth quarter last year and the third quarter of this year. However, our hosted revenues grew to 73% of total revenues versus 64% last year and 70% last quarter. We’re optimistic that during fiscal 2009, we’ll begin to see a return on our investment through increased revenues and decline in the growth of operating expenses. Heidi will provide additional details on our financial results shortly.

In our last call, we expressed optimism about the market response to Lyris HQ and the new business pipeline, and that outlook was confirmed by the significant in Lyris HQ customers. We have increased the number of Lyris HQ customers since our last call to 325 from 130, and we continue to average approximately two seats for HQ customer. Included in our 325 customers are 15 clients that access the HQ platform via Lyris HQ for Agencies. These agency accounts have created an additional 41 subaccounts, and I’ll discuss Lyris HQ 40s in some details shortly.

We’re seeing adoption across a wide variety of industry sectors and among both our additional SMB market and larger enterprise organizations. Lyris powered NBC’s Summer Olympic online marketing campaign and recent new clients include Harte-Hanks, a leading direct marketing company; Char-Broil, a major BBQ grill manufacturer; and Carters, a well-known baby apparel company.

Two key factors that are helping to drive market adoption of Lyris HQ, but first is the product offering itself. It represents a completely different and unique solution for online marketers through its ease of use, integration, and feature set. We’re also continuing to upgrade this offering in our most recent release that occurred in August offers a dramatically enhanced use interface, team collaboration tools, and new functionality. This new version includes a more user friendly desktop-like interface, a consistent look and feel across all applications, and new dashboard features. Other new elements include an improved online calendar and message board.

In conjunction with the release of the enhanced Lyris HQ, we also rolled out Lyris HQ for Agencies, which is targeted to marketing and advertising firms. This [inaudible] offering enables agents and resellers to manage your customer’s online marketing campaign by providing a complete online marketing toolset that they in turn sell to their clients. We had already had a strong presence in this market to our EmailLabs offering and, as we have discussed with you in the past, we believe the agency market is an important opportunity for Lyris HQ as well.

The second factor driving our growth is our expanded sales and marketing effort. On the marketing side, we have increased our visibility through press and analyst tour which has led to broad media coverage and favorable commentary by both Forrester and Jupiter, including our Clicktracks feature receiving a favorable review in the JupiterResearch Web Analytic Buyer’s Guide 2008 Edition.

On the sales front, we’re delighted with the addition of Brian Bailard, Senior Vice President of Global Sales, who joined the Company about a month ago. Brian comes to Lyris with more than 20 years of technology company sales management experience, including companies that provide web-based technology through software as a service model. Brian’s currently reviewing our sales strategy to insure we’re maximizing the value of our investments in this area.

During the year, we have increased the sales of our sales and account management team by more than 30 people and now have field sales offices in 30 cities. To compliment our expanded sales programs, we are increasing our tradeshow efforts and have participated in several recent events including SCS, San Jose, Internet Retailer, and ad:tech Chicago. We will also be participating in several more key events prior to the end of this year.

In addition to the improvements to Lyris HQ that I mentioned earlier, we also realized a major milestone in the product development with the release of Lyris ListManager 10.0. This upgrade reinforces our presence in the software market and includes a number of features designed to enhance deliverability including MailStream optimization, a new feature that enables markets to offer email delivery advantages to their most important subscribers by grouping multiple IP addresses, facilitating mailings in parallel. This not only enhances deliverability and tracking but also increases the speed of delivery.

The past year has been an important one for the Company ranging from the name change we implemented a year ago to our increasing market presence. Our key accomplishments in the past year include introducing our integrated platform that incorporates all of our core offerings along with new features such as [inaudible]; continuing our technology leadership with both a unique hosted solution and ongoing improvements to our software offerings; enhancing our sales and marketing organizations and broadening our channel programs through offerings such as Lyris HQ for Agencies; completing a Company-wide integration plan that merge our three U.S.-base subsidiaries into a single operating entity; realizing revenue growth, particular recurring revenues which now represent 86% of our total revenues; conducting transactions that strengthen our balance sheet such as the conversion of the large sellers note into equity; and, finally, enhancing our management team and operating infrastructure.

During the year, we appointed Blaine Mathieu as our Chief Marketing Officer, Heidi Mackintosh as our Chief Financial Officer, and most recently Brian Bailard as our Head of Global Sales. Each of these executives brings with them substantial industry experience that will be important to Lyris as we build our future.

I would like to now turn the call over to Heidi; but when she is done, I will come back for some closing comments.

Heidi Mackintosh

For the quarter ended June 30, 2008, Lyris had revenues of $10.8 million, which flat for our reported revenues in the fourth quarter a year ago and down slightly from $10.9 million in the third quarter of fiscal 2008. As has been the case for the past couple of quarters, our revenues reflect both the market shift in host of solutions and the impact of our transition selling the Lyris HQ offering. For the year, our revenues were $43.2 million versus $39 million in fiscal 2007, representing an increase of 11%. In terms of the fourth quarter and fiscal 2008, hosted software revenues accounted for 73% of total revenues. Licensed software accounted for 11%, maintenance support for 13%, and professional services accounted for 3%.

Gross margin in the fourth quarter on a GAAP basis was 62%. This compares with 71% a year ago and 63% in the most recent quarter. The declining gross margin versus a year ago reflects the impact of increased costs related to our fiscal 2008 hiring initiative and our investments and the enhanced functionality and build-out of the Lyris HQ that Luis referenced during his comments.

Our headcount at the end of the quarter was 250 versus 165 a year ago. We believe that we now have the people in place needed to grow the Company and expect to be making only incremental additions to headcount during fiscal 2009.

The increase in operating expenses resulted from several key factors, including our expanded sales and marketing initiative and increased spending in research and development to support Lyris HQ. In addition, we incurred higher costs related to our first year of Sarbanes-Oxley compliance and recruitment fees as we built the organization to support Lyris HQ and future growth. We also incurred certain compensation expenses that we do not expect to reoccur in subsequent quarters, such as a large payout for accrued vacation that resulted from a change in our vacation accrual policy. Overall, we are expecting our operating expenses as a percentage of revenue to improve beginning with Q1 2009.

As we have in prior calls, we provide three measures of our financial performance - GAAP, non-GAAP, and adjusted EBITDA. As a reminder, non-GAAP results include share-based compensation expense, amortization of intangibles, other income, the gain on debt extinguishment, and gains or losses on discontinued operations. Adjusted EBITDA is populated as earnings before interest expense, taxes, depreciation, and amortization, non-cash stock compensation, other income, the gain on debt extinguishment, and gains or losses on disposal of discontinued operations. Our reconciliation between our GAAP and non-GAAP net income and between GAAP net income and adjusted EBITDA can be found in our earnings release at www.lyris.com.

On a GAAP basis, the Company reported a loss of $2 million or $0.02 per share. This compares with GAAP net income of $2.1 million or $0.02 per diluted share in the same period a year ago. On a non-GAAP basis, the net loss in the quarter was $839,000 or $0.01 per share versus non-GAAP net income of $2.2 million or $0.02 per diluted share in the same period a year ago. Non-GAAP net income in the quarter includes $256,000 in stock-based compensation expense, $869,000 in amortization of intangibles, and a gain on discounted operations of $4,000. In the prior year, non-GAAP net income excluded stock-based compensation expense of $184,000, amortization of intangibles of $1 million, and a gain on discontinued operations of $1.1 million.

Adjusted EBITDA for the fourth quarter of 2008 was a loss of $478,000 versus earnings of $3 million in the fourth quarter a year ago and excludes the same items referenced in the non-GAAP discussion.

With respect to the balance sheet, we amended our credit agreement covenant related to EBITDA with Comerica Bank at the end of July when our preliminary financial results indicated that we would not meet our minims EBITDA requirement. As a result of our year-end audit, we reversed the sale of a software license that has been accounted for in a prior period and had become a subject of a dispute. The effect was to reduce the Company’s EBITDA below the amount required by the amendment and Comerica provided a waiver of this covenant for the June 30th compliance period.

I would now like to turn the call back over to Luis.

Luis Rivera

I’d like to conclude our presentation by providing a brief perspective on fiscal 2009 and outline what I see as our operational objectives for the year. We believe we’re in a very strong competitive position with our Lyris HQ product, a view that is being validated by the market’s rapid acceptance of the offering. We feel we will extend this competitive advantage with the implementation of enhanced versions of the platform and as we incorporate new features over the next several months. No other company has been bale to bring such a highly integrated online marketing tool to the market, and we believe we have a significant lead over anyone who might be developing a competitive offering.

In addition, the trends regarding the allocation marketing dollars are providing a nice tailwind for us as companies see online marketing and advertising as a mechanism to provide an increasingly favorable return on investment when compared to more traditional forms of media.

Based on our product development strategy and the market environment, we see the following as key milestones for this fiscal year: Refining Lyris HQ leading to a more fully integrated offering by the next sprint, fine-tuning our sales and marketing programs to increase market share for Lyris HQ, expanding our channel programs by increasing our presence with marketing and advertising agencies and other perspective resellers and, finally, managing our operating expenses while accelerating our revenue growth to improve operating efficiencies while achieving a greater return on our investments of the past year.

Thank you again for joining us today, and I will now open the call to your questions. Actually before I do that, just a quick clarification: I mentioned we had 30 field offices, at this point it’s actually 10 field offices. But with that, I’ll open it to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from [Mado Kadolle] – FertileMind Capital.

[Mado Kadolle] – FertileMind Capital

A question on the strategy of going with Lyris HQ and completely deemphasizing your standalone product, which is EmailLabs and Lyris which you have substantial customer-base, how is that strategy working out? Are you convinced that this is the right strategy going forward?

Luis Rivera

What we’ve seen is that as customers have evolved and they have been looking to a more sophisticated things, just the single standalone applications are not necessarily what people are looking for. Particularly, as people add more marketing dollars towards this kind of medium, the reality is they really want to be able to understand as a whole what a campaign is doing. So through the combination of our products EmailLabs and ClickTracks and our Web content management tools, we’re able to provide them a much better picture as to what their campaigns are doing and so we’ve seen the uptake be pretty interesting as to what people think and how they start using HQ. So we know HQ is the combination of really four/five different products and people are using more than just whether it’s email or whether it’s Web [inaudible], we’re seeing people using a large amount of the other tool. So the answer is that we find it very interesting to be able to offer one application that makes us completely different than anybody else’s [inaudible].

[Mado Kadolle] – FertileMind Capital

So out of the 325 customers that you signed up, one quick question on that, do you separate the 41 subaccounts from the agencies or is that include? How do you count that number?

Luis Rivera

No, we don’t. Basically the 325 is 325 accounts and within those accounts we then have another 41 that you could add and say, ‘Okay, it was really 370.” But we don’t look at it that way; it’s really 325 accounts truly paying us and true accounts.

[Mado Kadolle] – FertileMind Capital

Out of the 325 accounts, how many customers have you seen using the entire suite versus part of the product? The question related to that is: Do customers see value in paying for the full bundle if they’re using or they’re not using all of that?

Luis Rivera

Yes, a very large majority of the customers are using at least two of our applications, and we’re seeing that increase.

[Mado Kadolle] – FertileMind Capital

One of your competitors, Omniture in the analytic space has the Genesis platform where in several, and I’m sure you’re aware of that, and I have noticed that they’re about 35 email service providers and several other PPC management companies, et cetera or some of your, not direct competitors but point competitors have been part of splitting the program. Have you thought about that?

Luis Rivera

Actually we initially, before actually acquiring the rest of the Company’s ClickTracks and Hot Banana, we actually were part of that partner list. What we very quickly found out is that we were not able to truly satisfy the demands of the customers because ultimately there was no one central company that was accountable for problems or for helping a customer out with how to accomplish a campaign or even beyond that, the integration were very superficial. So the answer is actually I believe that through EmailLabs, I don’t know if we still are, but we were certainly part of that and it’s not necessarily something that we saw a lot of benefit from. It was mostly at least for us, it certainly was a good press release, but I don’t think it’s much more than that.

[Mado Kadolle] – FertileMind Capital

Could you tell us a little more about in terms of… You added a lot of sales people in the last six to nine months, how they are performing? How many of them are reaching their quotas? Secondly, a follow-up to that is: What kind of marketing equities specifically you are going after?

Luis Rivera

We did add a decent amount of sales people. What we’re seeing is that some of them are starting to ramp up and so it really is: We believe that going forward we will see better return on investment from those particular sales people. A large portion of them are fairly new and it wouldn’t be until now that we really start seeing them perform.


As to our marketing activities, it’s ranged. We have basically started marketing as one company rather than point solutions, so that a big change. We still clearly advertise in the point solutions category, but again we feel that we’re the only player out there who can really claim to have a digital marketing solution rather than an email and web analytic. So that’s a pretty big change. Second change is the kind of venues that we go to because of that. So actually today and yesterday, we’ve been at stop.org, which is more of the retail kind of show and the show that we had historically not participated because under our pure email marketing space, it may not have been the right show for us. So again, we’re doing a lot more tradeshows as well as a lot more different kinds of outreach out there whether it’s on a regional basis or whether it’s a national basis, as well partnering with people such as agencies in order to go after specific verticals.

[Mado Kadolle] – FertileMind Capital

You have roughly 27/30 sales people, I believe, how many of them are now meeting their quota?

Luis Rivera

Roughly about half of them.

[Mado Kadolle] – FertileMind Capital

As to the Comerica covenants you have the rest I guess next fiscal year, how confident are you that you’ll be able to meet those covenants in terms of EBITDA numbers?

Luis Rivera

Right now I’m really moistly focused on a quarterly basis. I think that we expect to be in full compliance for this quarter. I also believe that as our sales team starts to add up, clearly we have a plan as to how we get to start meeting those covenants. But by the same token, I would tell you that as you have seen in the many filings and amendments that we’ve had with our bank, we have a very good relationship with the bank. We both feel very good as to where the business is today. One key thing that has been happening is that our software revenues I think are coming down, but really our hosted revenues have offset that and that ultimately is a much better opportunity and possibility for us as a Company.

Operator

Next we will go to William Martin with Raging Capital.

William Martin – Raging Capital

Maybe you could just talk a little bit about the expense side and you mentioned some integration savings and did you really go from 30 to 10 field offices?

Luis Rivera

I corrected that; it was a mistake when I spoke. We really have ten field offices out there.

William Martin – Raging Capital

Well in general can you just talk about what kind of integration savings you’re looking at?

Heidi Mackintosh

We have seen some savings from integrating those offices and those locations into a centralized location. We now have pretty much centralized accounting for all of those locations as well as other services that we offer. We did incur last year some significant one-time expenses that will reoccur at a very smaller amount such as our first year’s Sarbanes-Oxley compliant. We spend a tremendous amount of effort in becoming compliant for Sarbanes-Oxley documenting all of our internal controls and processes, which in the past we had not had formal documentation in a lot of that area. So we do see improvement. We have hired quite a few people over the last year, but we believe we’ll see the return from that investment in the coming year. We won’t have, like I mentioned in the call, that we had one-time payout on vacation accrual. In the past, we’ve had no cap on our vacation and so the accrual had gotten quite large for a people so we’ve implemented a cap that we kind of pay out this year. So there were some one-time charges that we don’t expect to reoccur. However, we also are keeping a close eye on keeping the expenses at a modest level and are hoping to see the revenues grow.

William Martin – Raging Capital

On the licensing side of the business, I know there was some I guess a launch delay in one of the versions, but more broadly I know you’ve been deemphasizing that side of the business. Can you talk a little bit about what the strategy there is going forward and what’s your expectation on the revenue side?

Luis Rivera

We actually saw, and you see this in our numbers, we basically have gone from roughly doing about 20% of our sales coming directly from our licensing, and in the last quarter that was actually 11%. As you mentioned, that was partially driven by us, but also partially driven by the market. It is true that hosted applications are what the market of today is choosing to go for and so obviously we’ve been spending less there but as well as probably most importantly we’ve really been adding that spend into our hosted applications and so that really makes it so that we’re able to come out with better, faster product. So we will continue to basically follow that path. Today, we still do have a very interesting business with our ListManager product in particular, and it’s a product that just got an upgrade literally last month and so we expect that that upgrade should do good things for us.

William Martin – Raging Capital

Can you just talk about the ASPs on the HQ, how do you sell that on a per seat basis, and what is the typical client ASP look like?

Luis Rivera

So is the answer related to what’s the pricing on HQ, or was it related to agencies?

William Martin – Raging Capital

No, the pricing, average selling price on a typical corporate client.

Luis Rivera

So we continue to see on average about a $2,000 fee on our HQ clients. It is true that the product starts much lower than but. But, as I mentioned before, we have normally two seats per account and on top of that, when you add the email volume, that’s how you get to about $2,000 per customer.

William Martin – Raging Capital

That’s per year?

Luis Rivera

That’s per month.

Operator

We will return to [Mado Kadolle] with FertileMind Capital.

[Mado Kadolle] – FertileMind Capital

That’s a pretty good improvement in the $2K per customer revenue per month. What was it like last month, last quarter it was $1,300, I believe?

Luis Rivera

It was a little bit lower than we have been seeing that per seat going up, but it hasn’t been going up by that much. I think the number last quarter was probably in the $1,800 or $1,900.

[Mado Kadolle] – FertileMind Capital

Luis, can you talk a little bit about competitive landscape? Looks like nobody else has a similar HQ kind of product which is integrated, but I’m sure you will have to run into point solutions. What are you sales people looking at? What are they competing with, and why or why not they’re running the deals? If you can even talk a little bit about of [inaudible], that would be helpful.

Luis Rivera

So the competitive landscape continues to be pretty much the same. On pretty much every single point ap we have competitors whether it’s on the email side or whether it’s in the web analytic side. It is also true that the competitors have been paying attention to what we have been doing and virtually every single website that I go to, they are starting to basically put together a similar story as HQ. Now as Bill mentioned, maybe it was you, there was Omniture, for example, was one of those competitors and that the real challenge for anybody is that it’s a different story to be able to say, “We’re truly integrated and here’s how we are integrated and if you have problems just call us, we’ll take care of it versus the story of: Yes, we have a partnership and therefore we do it this way. So that’s one side of it.

By the same token, what customers are starting to realize because they’ve been through these before is that partnerships are not necessarily the best way. So when customers approach us, we’re able to truly show them how is that our application is better and why is it they should go with us. So we have started to see that we more we build out HQ, the better our closed ratio is. Interestingly enough beyond that, what we start seeing is that the customers are using more of each single point solution, so that also benefits us because there is no other solution that it can really turn to once they start using several of those applications out there. So we’re excited about what we see.

We also see that every month we’ve been basically releasing more of HQ as we see it and so that’s why I mentioned this spring timeframe because by that point we’ll really start to have a product that’s truly built out and a product that’s completely unique in the market. Given where we are today, I don’t think that there’s anybody out there who comes close to us. So, again, we’re excited about what we see. We think that our win ratio can only increase, and we think it’s actually pretty decent as it is.

[Mado Kadolle] – FertileMind Capital

In the current economic environment, have you seen [inaudible] getting slower? What do you see out there?

Luis Rivera

Sorry, I have seen the competition getting slower?

[Mado Kadolle] – FertileMind Capital

No, the sales calls and some sales call to the closing, has the sales cycle lengthened generally?

Luis Rivera

There’s two parts to that. On the software side, the answer is those tend to be larger sales and the answer is yes, we sort of expect that to happen. As such, again, we have deemphasized to a large degree our software. On the hosting side, the answer is no. I think that’s what happening is that more people are actually switching from software and saying, “Okay, well we may not be able to spend $100,000 on a large software purchase, but we certainly can afford to basic pay $2,000 a month. So I don’t think that we’re seeing any cycles get longer. I think that we’re actually seeing more interest from more companies that have historically been really focused on having those purchases inside their firewall actually having experts manage their campaigns.

[Mado Kadolle] – FertileMind Capital

Do you track some sort of backlog or any kind of pipeline activity?

Luis Rivera

We do. We like what we see.

Unidentified Analyst – FertileMind Capital

You mentioned that you’ll have a fully integrated product by the spring time. I’m just curious if you can 1) give us some of the features that will be enabled by having a more fully integrated product and 2) that’s six or seven months away, just curious why it takes so long considering this a SAS model.

Luis Rivera

You’re absolutely right, it is a SAS model and so therefore I don’t expect it to basically show up in springtime and be all done. What you’re seeing is every month we actually release iteration. So let’s assume that the product let’s say even 60% where we want it today, by next month I expect it to be at 65% and next month 70%, so each one of these releases that we put out there is very meaningful. Now where it gets really interesting is that we’re actually adding new functionality to the product that just makes it easier to work with and really a product that people will be very impressed with. Things that we’re currently working on right now is our asset managing library. That includes things such as being able to not only run an email campaign, but really being able to with the same asset management library being able to handle your website and being able to handle pretty much every component of every campaign you have. That makes it a complete different product as well as clearly we’re still cleaning up a little bit of the interface. Beyond that there’s things such as just making the product be capable of completing another area by making the product easier and making it let’s call it [inaudible] and/or just easier to use. We’re actually even able to target different segments of the market. Today, we’re very focused on that to be as we make the product be easier we can target certainly the very small end as well as by adding more complex features, we can actually start targeting higher [inaudible], which we already have actually and we’ve been fairly successful with. So it’s basically not just really finishing the product, but having a product that can pretty much go in different areas of the market.

Adam – FertileMind Capital

A question about the HQ for Agency: How does effect the economics of this average monthly revenue of $2,000? Is that when you go down the end client, are they garnering $2,000 in revenue and then the agency takes its piece or maybe you can talk about the math?

Luis Rivera

The way the agency actually works, there’s different price points. It starts at a $1,250, but clearly goes up into the thousands. By thousands, I believe we currently have a customer that is roughly paying us somewhere about $2,500. So the way that that model works is that with each different price point, they have different keys and they also have different amount of clients that they can have in there as well as different kind of email volumes. So to answer your question: I don’t really know what it basically do to our average price point. As I mentioned before, we actually take that number out. We only really look at… We don’t look at the subaccounts initially.

Operator

I show no further questions at this time, Mr. McDonald.

Richard McDonald

That’s all we have. Thank you very much, and we’ll look forward to speaking with you again next quarter. Thank you.

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