Crexendo, Inc. (CXDO) Q3 2008 Earnings Report, Transcript and Summary

Welcome to the iMergent third quarter fiscal 2008 earnings conference call. At this time all participants are in a listen-only mode. Following management’s prepared remarks we will hold a Q&A session. (Operator Instructions) I would now like to turn the conference over to Ms. Chapman.

Thank you. Good afternoon and thank you for joining us for the iMergent third quarter fiscal 2008 conference call. With me today are Don Danks, Chief Executive Officer, Brandon Lewis, President and Chief Operating Officer, Rob Lewis, Chief Financial Officer and Jeff Korn, General Counsel. After reading a Short safe Harbor statement I will turn the call over to Don Danks who will provide an overview of the business. Then Jeff Korn will provide a legal update. Rob Lewis will review the financials. Brandon Lewis will discuss the operations and then Don will open the call for questions. Statements and comments made on this call that are not historical in nature constitute forward-looking statements within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements and comments are based on the current expectations and beliefs of the management of iMergent and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements and from management’s current expectations. For a more detailed discussion of factors that affect iMergent’s operating results please refer to its SEC results including its most recent form 10K and 10Q. The company undertakes no obligation to update this forward-looking information. With that I will turn the call over to Don Danks, Chief Executive Officer.

Thank you very much Kirsten. Thank you all for joining us on our call today. We are implementing a plan to ensure a long-term viable business that will drive profitable growth and we are very excited about our progress. In fact, for the past few quarters we have posted sequentially better financial results with increased cap from operations and improved profitability. Before I go into detail, I will summarize some of our financial results. Our total revenue for the third quarter of fiscal 2008 was $27.6 million. Net dollar volume of contracts written, a relevant and meaningful statistic to understanding the operations of the company was $26.5 million. As we are in the re-building phase after intentionally reducing our sales teams, as projected both figures are lower than last year. Our 2008 goals are to appeal to a wider audience, improve sales via enhanced conversion rates, build new and recurring revenue streams via ancillary products developed both internally and with partners, and maintain our commitment to superior customer service while continuing to explore new channels of distribution through our eCommerce products and services. As such, we introduced a new business model based on integrating Stores Online Express into our preview sessions and continuing to offer Stores Online Pro at our one-day workshops. We are driving long-term change and recognize this implementation takes some time. Since we started in September 2008 (sic) we have improved each quarter. When comparing the second quarter 2008 to the third quarter 2008 we increased our close rates from 27% to 29%. We drew our average selling price from $4,800 to just over $5,000. We improved operations from a loss of $143,000 to income from operations of $737,000 and we grew cash provided from operations from $2 million last quarter to $4.6 million this quarter. Also during the third quarter we met our target of introducing Stores Online Express at all preview sessions by March 31. The initial results were positive as close rates and average selling prices increased, which we believe validates the Stores Online Express business model. Then in April we were pleased to hold two Stores Online Express preview sessions and one workshop in California. The market continues to grow. Our Stores Online Express Model is gaining momentum and investments made to training our sales teams and material refinement are paying off. However, as updated on April 1 the roll out was more expensive than anticipated. Additionally the percentage of customers paying with cash decreased from 60% to about 50% which we believe is attributable to the economy as consumers are tending to use credit over cash. All considered, we have narrowed our guidance for fiscal 2008 revenue and net dollar volume of contracts written both to be between $127 million and $132 million. Nonetheless, our commitment to deliver shareholder value to our investors is steadfast. We continue to repurchase shares of our common stock. Since the programs commitment in August 2006 we have purchased over 1,586,000 shares for approximately $26.1 million. We also continue our quarterly cash dividend of $0.11. The most recent payment on March 10 brought the total amount paid to shareholders to date of $6.3 million. With that brief overview I’d now like to turn the call over Jeff Korn for a legal update. Jeff?

Thank you Don. First I want to comment on questions we get from time to time on certain litigations and why from time to time we either file motions to continue or file objections, which may seem to delay matters. I normally do not discuss individual motions or actions in litigation that we take. I do, however, want to indicate that motions to continue or objections are done as part of a comprehensive litigation or settlement strategy. I do not and will not discuss the rationale behind every step we take because it is not a good idea to disclose to our opposition what our specific strategy is. I meet with and hold discussions on a regular basis with states who have actions or otherwise have questions about the company. We stand ready to act in good faith and to make appropriate accommodations. As you now know I was engaged in meetings with both the AG and DA in California last year while litigation proceeded. We are happy to work with regulators and hopefully resolve any open issues. We have never admitted to any wrong doing and we are steadfast in our belief that we have acted properly and we never mislead customers. We make decisions on settlements based upon the reasonableness of the settlement offer, what is expected and what the excepted cost of settlement relative to the projected cost of proving our position would be important. If necessary we stand ready to take any pending action to trial and present our position to a court. Nonetheless when faced with state personnel who act in good faith we strive to resolve matters. Our most recent resolution in Connecticut is proof of that. The investigation there started almost two years ago and we have been engaged in discussions ever since. Connecticut like most states investigations stemmed from customers of years ago before we made the substantial and quantified improvement to our customer service and prior to the Stores Online Express Model. Let me now discuss California. This is a very important part of our business and our being able to transact business there is important to the company and to me. I want to make clear it is also important we do business in compliance with the law and follow the Court Order which has been entered. As I indicated, I personally had meetings with the State where our business model was discussed in great detail. I made clear at that time and subsequently that I believe our Stores Express Model did not violate the Injunction and was also not in violation of the Sellers Assisted Marketing Plan Act. The Injunction prevents us from selling a product that has an initial required consideration of more than $500. The Stores Online Express software we sold in California had a price of $50 when it was sold at two previews held on April 19th. The people who purchase Stores Online Express, which is a stand alone, fully functioning tool, were invited to attend a workshop on April 25th. Those who purchased were allowed to upgrade to Stores Online Pro and Stores Online Platinum. I will not discuss the results of those seminars in light of the pending litigation. The State was fully appraised of our actions and was invited to attend. I saw nothing at the seminars which has led me to change my belief that we are allowed to hold the Stores Online Express Seminars in California. The State has not rendered its opinion but has made clear that its failure to act is not an admission that it has acquiesced to my position. I believe it is important to continue to tread carefully as I want to show the AG and the DA, as well as the court, that we are operating in nothing but good faith. I intend to continually inform the AG and DA of what actions we are going to take. I have, however, asked Brandon to set four more previews and two more workshops. They will probably be set in July. I will at this time not provide any further detail as I want to fully provide the information first to the State when the dates are set. On all other matters we are proceeding expeditiously and where appropriate aggressively. We will continue to work with States to both resolve pending actions and try and prevent future actions. We believe as a company it is in our best interest, the interest of our customers, and for that matter the interest of regulators for us to be transparent and fully open and honest. We strive to do that every day in every transaction. With that now I’ll turn the call over to Rob for a financial review. Rob?

Thank you Jeff. As mentioned earlier in addition to revenue recognition each period in the income statement management believes the net dollar line with contracts written is a meaningful and relevant statistic to the understanding of the operations of the business and represents gross dollar contracts written during the period, less estimates for bad debts, discounts incurred on sales and trade receivables and estimates for customer returns. During the quarter ended March 31, 2008, we conducted 204 events including ten internationally compared to the third quarter 2007 with 320 workshops including 91 internationally. The decrease in number of workshops conducted is primarily attributable to the decrease in employee base which occurred in December 2007 in an effort to effectively launch Stores Online Express. Total revenue was $27.6 million compared to $42.6 million for the quarter ended March 31, 2007. Net dollar volume of contracts written was $26.5 million compared to $49.1 million for the previous year’s quarter. Total operating expenses were $26.8 million for the current quarter compared to $36.7 million for the same period last year. The decrease reflects fewer workshops and second quarter cost reductions which were partially offset by increased training expenses associated with the rollout of Stores Online Express. General administrative expenses were $5 million for the current quarter compared to $4.1 million for the third quarter of last fiscal year. The increase was attributable to additional customer support costs of $241,000 due to an increase in volume of customers utilizing our software, an increase in financial servicing fees of $265,000 resulting from the increase of collections from trade receivables, and an increase of $107,000 in legal expenses. The remaining increase is attributable to an increase in general operating expenses associated with the launch of Stores Online Express. Net income was $1.7 million or $0.15 per diluted share in the third quarter of fiscal 2008 compared to net income of $4.7 million or $0.36 per diluted common share in the third quarter of the prior year. For the first nine months of fiscal 2008 we held 806 workshops including 119 internationally compared to 860 workshops including 194 internationally during the nine months ended March 31, 2007. Total revenue was $98.9 million compared to $107.3 million in the same period of fiscal 2007. The income tax provision for this period was $1.9 million compared to an income tax benefit of $676,000 for the same period of last year which resulted from a non-recurring benefit that was recognized upon the removal of the valuation allowance against $7.7 million of deferred income tax assets. For the nine months ended March 31, 2008, net income was $2.6 million or $0.22 per diluted common share compared to net income of $18.7 million or $1.45 per diluted common share in the same period of fiscal 2007. Regarding the balance sheet, as of March 31, 2008 we had $25.2 million in cash and cash equivalents. During the quarter the company repurchased 328,053 of its common stock for $3.5 million. Additionally, from April 1, 2008 through May 6, 2008 the company has repurchased over 112,000 for $1.4 million bringing the total shares purchased since the program’s commencement in August 2006 to over 1,586,000 shares for $26.1 million. As of March 31, 2008 we had working capital of $20.9 million and current deferred revenue of $33.9 million. The deferred revenue balance represents historical sales for which the company cannot immediately recognize revenue. The cost of expenses we incur as these deferred revenue amounts are recognized as product and other revenue are expected to be insignificant. Consequently we do not consider deferred revenue to be a factor that influences our liquidity or future cash requirements. Working capital net of current deferred revenue as of March 31, 2008 is $54.8 million. Now I’ll turn the call over to Brandon who will provide you with a review of the business. Brandon?

Thanks Rob. As Don mentioned we are in the process of evolving our business model and improving our marketing. Our decisions and actions are to deliver a long-term viable business and we are very excited about our progress. During the fiscal third quarter we increased our close rates from 27% in the December quarter to 29% and the average selling price from $4,800 in the December quarter to just over $5,000. We do believe the Stores Online Express model is positively impacting the buying unit conversion rate. The percentage of cash purchases was around 50% which was lower than the prior year, which we believe continues to reflect buyers’ uncertainty about economic conditions. The average number of buying units attending the workshops for the quarter was 84 compared to 82 during the December quarter and 95 for the fiscal third quarter of 2007. We attribute the decrease to response rates to our advertising and to attendance at our preview sessions. We are in encouraged, however, by the sequential increase in these statistics. Additionally, we continue to train our speakers with the new curriculum this quarter. In an effort to train sales people and speakers we did send out more sales people to our preview seminars. This brought on more expenses for both travel and salaries. We are quite pleased, however, that we met our goal of rolling out Stores Online Express to all preview sessions by March 31, 2008. We have started the Stores Online Express rollout in the U.S. and our goal is to emulate the launch process internationally which we expect will require some adjustments to serve those markets appropriately. In addition, we conducted as Jeff said, two Stores Online Express preview sessions and one associated workshop in Orange County, California in May. As noted, we have been re-engineering the company with management focused on delivering the best experience for our customers. We believe we will have dialed in our marketing and new preview presentations in the coming months. Then we will direct our full attention to increasing customer activations and continuing to build our recurring revenue. We have differentiated our software offerings. First, Stores Online Express offers our customers an outstanding website builder with minimal marketing and processing integration. Stores Online Pro, on the other hand, provides the customer with a one-website license, access to Avail and all of our excellent marketing tools, processing and integration. Finally, we expanded and updated our Premium offering now labeled Stores Online Platinum. Platinum provides all that Pro offers plus drop-shipping integration and the ability to receive unlimited site tease which allows the customer to activate unlimited websites when needed. Avail, as you may recall, is our automated virtual telecommunications, email and fax management system that enables customers to manage their customer inquiries. Avail is now bundled with the software but requires a monthly hosting fee which we hope contributes to our future recurring revenue growth. Also, we are establishing a special task force to evaluate additional means of distributing our software. All in all we continue to be proud of our award-winning customer support but we are not resting on our laurels and we promise that we will continue to work to improve that area. I now, Don, turn the call back to you.

Thank you very much, Brandon. In summary, by adjusting our business model and re-engineering our company we have positioned our company for future growth. Although our revenue is down year-over-year we have bettered our financial performance sequentially. I’d like to compliment the management team on delivering two quarters of profitability during this transition process. We are very proud of that. We are not done yet. We continue to refine our curriculum and improve our marketing. We are optimistic in the fourth quarter of 2008 we will continue our trend of improving our financial results sequentially. We are very excited about our results and progress and as Brandon noted we continue to drive forward to increase customer activations and recurring revenue. Now with that I would like to open the call to questions. Operator I will turn it over to you.

(Operator Instructions) Your first question comes from the line of Neil Goldman with Goldman Capital Management.

A couple of quick questions on the extra costs in the third quarter. You said it was $107,000 incremental legal. Was that over the second quarter and what was the total legal cost associated with this?

As far as the legal costs the $107,000 is above and beyond the third quarter of last fiscal year. My script was comparing this quarter to last year’s quarter.

How much was that in total?

As far as total legal expense it was a little over $500,000 this past quarter.

And for the year overall? The nine months?

$910,000.

All of this is associated with these prior legal things whether it is California, etc.?

Correct. It is primarily associated with these actions.

What were the incremental costs related to training, sending people in, extra airfare, etc. in this last quarter?

It is difficult to quantify that because with the number of teams we sent out some had additional people and some did not. We didn’t actually segregate that out in our financial statement this time but we did have additional team members out with a lot of the teams throughout portions during the quarter.

One you said additional customer support of $241,000.

That didn’t have anything to do necessarily with the rollout of Stores Online Express, it is just we have a lot more customers utilizing the software and so that is just how much our costs increased during the quarter compared to last year’s quarter.

Is it fair to say the legal, which hopefully one day goes away, and the customer support was probably at least $0.05 per share after tax?

It probably could be said that, yes.

What was the recurring revenue in the third quarter as a percentage of overall sales? When you talk about hosting and Avail and things of that nature.

We historically have not given that number out and we continue to believe…I will say it is less than 10%.

As the new model rolls out I assume the whole purpose is to have a significantly greater percentage.

It is. While revenues are decreasing those recurring revenues are increasing. So despite the fact we’ve had decreasing revenues we have had increasing recurring revenues throughout this process.

Brandon when you talk about range for the fourth quarter it sounds like somewhat up $28 million versus $27.6 million to as much as $33 million, right?

Yes.

What would be the differences? You know pretty much how you planned…

I think ultimately there is a nice comfort level in our conversion rates at the workshop and our new packaging of our product. We’re really, really confident and comfortable with the way that is progressing. One of the difficulties, Neil, that we have had as have many training companies I think in our space is people have not been responding as well to our marketing piece as they have in the past and so that range is really attributable to those marketing response rates. That is where that range comes in.

So besides the economy what would be the other variables in that?

It is hard for me to say. Because I have talked to a number of people in the training industry and they are all experiencing it, I think most people have concluded it is the economy and people are hunkering down and are not as interested in spending money and time on training as they have in the past so they are just not responding quite as well. Interestingly enough, if you compare our results in terms of marketing in comparison to what I’m hearing is going on out in the marketplace I think we are doing real well but not well up to our standards. We just need to improve there. We have seen some really nice trends in a lot of our testing of our new marketing pieces and with some of our data modeling that we have been doing and I’m optimistic we are going to see some of those results go in the right direction.

When you look at now you have 6 teams down from 9 teams at one point. What is the potential on a quarterly basis on the up front sale between the Express and the Pro? You got as high as $45 million I think in the last year some time.

I guess I actually wouldn’t have that number just off the top of my head in terms of the potential revenue off of those 6 teams. One of the things you heard in our script was we saw an average of 84 buying units per workshop, which is down from 96. That is kind of in our sweet spot, that 90-105 buying unit range. So I think you could probably do the numbers. If you gave me a minute I could probably get to that number as well. But that is kind of the sweet spot. Once we start going above that there is just some diminishing returns. It doesn’t mean we couldn’t figure out how to be efficient to those larger crowds but that has typically or historically been in our wheel house so to speak.

But there is no reason you won’t get back to those 90-type of things?

No. Actually in the month of January, for example, we were actually in that range and it just slipped because of response rates in February and March. So, there is no reason why we couldn’t.

In terms of that incremental volume, you bring down what 50-60% of sales on incremental volume of sales in the new model?

I don’t know that I really understand.

The range of 28-33, right? On every incremental dollar of sales…it is the same number of seminars?

The closing rate as we talked about in the script was up a couple of points over last quarter and although we haven’t broken out what the difference between Express closing rates and our past closing rates are you can conclude that our Express closing rates were over 29% because probably a little more than half of all of our events for the quarter were under the old model, not the new Express model.

Therefore, the incremental volume should bring down round numbers $0.50 on the bottom line. Is that right, Rob?

What was that again, Neil?

Would it bring down an incremental 50% on an incremental dollar of sales?

Yes, because that is all margin to us because it’s a fixed cost associated with the workshops. The only thing I’d also add to Brandon’s comments is that our workshop teams aren’t quite at capacity yet so there is additional capacity. There are more workshops to be conducted for each team.

Our teams are not only not seeing the maximum number of buying units but they are not doing the maximum number of workshops they could do on a monthly basis.

The size of the tax, less carry forward, Rob, at this point is how much?

As far as the tax, less carry forward, is about a little over $10 million. About $10.1 or $10.2 million.

Is that against pre-tax or against?

That is after the tax. After the tax effective.

The next question comes from the line of Jeff Bass, private investor.

I want to follow-up on the guidance a little bit. Brandon had said the range really was related to the response expected from the marketing pieces and that is with the events. However, I think the point he subsequently made was that when we go from maybe 50% on the Express Model base to a 27% buy rate at workshops to the full Express model that in itself could add roughly 10% of highly profitable sales to the mix. So wouldn’t it be fair to say that the range should also reflect the incremental that you expect to get from the Express model?

Yes. Definitely the margins will improve. I think that is a valid point.

My next question is with respect to receivables. I noticed that the reserve on gross receivables dropped over 1% from the last quarter under the more challenging credit conditions you might have expected it to go up. Is there any particular reason for that?

The reason why is our sales volume has actually come down. We are actually pumping less receivables into our pool but the receivables that are there from our past are actually performing well. We have been getting…paid to defaulted.

You are pumping less of higher risk and additional month receivables in.

Exactly.

On the other hand I noticed long-term receivables dropped nearly 25% from 12/31. Is there any particular reason for that?

Once again because of the decreased sales volume all of our historical receivables are now getting into…if you recall we did a lot of volume in the March quarter of last year. Those are now beyond 12 months or within the 12 months…zero to twelve months that are in mature so that pool basically became current. So that is the big reason why the decrease. We are not pumping in as many receivables as we did last year’s quarter and so that is the reason why. You’ve got more current now than you do long-term.

Finally, I know the 41.8% tax rate for the current quarter. Have you ever given any thought to retaining a consultant to examine whether there are any tax strategies the company could use to be helpful in getting that rate down?

To a little bit more of a reasonable amount? We are looking at that. The big things that drive our rate right now are the expense we recognized for incentive stock options that were granted to employees in the incentive stock option expense. Then we have other permanent different items such as business meals and entertainment for which we are only able to deduct 50%. We are going to be looking at…we have already talked to some tax consultants about trying to help us strategize to help us reduce that tax rate. But it is those permanent items like incentive stock option expense and business meals and entertainment that are really impacting our rate this year.

I noticed you only did ten international workshops, which is down considerably from the prior quarter and also I think from the quarter a year ago. Does that affect this 84 average buying units any? What I’m getting at is it is my recollection that historically having the international workshops had better results than the domestic ones in some respects?

You’re dead on, Jeff.

With respect to both the cash thing and the size?

You’re dead on. Historically our experience has been we have gotten better response rates to our marketing internationally and they have paid with more cash. You are dead on there.

I can see that you wouldn’t have necessarily wanted to do a lot internationally if you were focusing on getting the company’s efforts on getting Express rolled out properly, but can we assume that we will get back to more normal levels of international workshops in the current quarter?

I think you’ll start to see us start to ramp, Jeff. I don’t think you should expect that we would get back to the normal levels. In particular maybe outside of Canada I think you can expect us to ramp rather quickly to kind of our past levels. However, outside of Canada I think you will see a slower ramp.

Is there any particular reason for this? Because the economics…

The main reasons, Jeff, are that in particularly in Australia we have had some issues as you know with the ACCC and we want to try to resolve as many of those as we can and deal with some of the PR issues. The other thing that is a little bit concerning to me and I want to make sure that we have our marketing dialed in is that in particular over in the U.K. postal rates have gone up quite dramatically. They had a huge rate increase that is going into effect here in the next few weeks. As well there was a rate increase in Australia. But we just want to make sure that we have it, as I mentioned in my script, dialed in before we start investing too heavily back in there with this new model.

We have no further questions at this time. Please proceed with your presentation or any closing remarks.

I’d like to thank everybody again for joining us on the call today. I’d like to thank the shareholders for their questions they had. We remain very committed to the growth of our business and we remain very excited about our product mix. Our positive changes over the past few months have already delivered results and we believe with more refinement we will drive sales growth, recurring revenue and increase and improve profitability. With that we look forward to talking with you after the end of our fourth quarter. Thank you very much for attending the call today.

Ladies and gentlemen that does conclude your conference call for today. You may now disconnect.