Our final goal is to establish the research and science that supports the Fast ForWord software applications as a market differentiator. Fast ForWord products are unique since they emerged from more than 30 years of scientific-based research on how the brain learns to read and the conditions under which brain function can be quickly altered to improve language acquisition and reading proficiency. This lab-based research was translated into a commercial product that was then exposed to a national field trail before being released to the market in 1996. Since the release of first the Fast ForWord product, hundreds of independent research studies have been conducted by universities, clinics, and school districts on the efficacy of Fast ForWord. These research studies continue both independently, as well as by our own research department.
The uniqueness of these software applications are also captured in the 70 patents with more pending. We were issued a new patent in the quarter.
During the quarter, Dr. Michael Merzenich, one of our founding scientists and Francis A. Sooy Professor at the University of California, San Francisco, was featured in Forbes, as well as interviewed on Good Morning America. Dr. Merzenich is also founder of Posit Science, a company focused on bringing neuroscience-based solutions to the cognitive problems of aging. As you will recall, we have licensed our patents and technology to Posit Science for a fee, future royalties, and equity. We also have a reverse license right to future patents that Posit Science secures from their research and applications.
In the quarter ten additional research studies were published on Fast ForWord. Five of these were independent school-based studies; four were from the international market (Australia, Germany, United Kingdom, and Singapore), and one from the Virginia Department of Corrections. You can access these research studies on our website by clicking on the results tab. Research continues to demonstrate that Fast ForWord software produces significant results fast, and these reading achievement gains endure over time.
I would now like to ask Jane Freeman to provide you with more detail on our financial results, as well as her own perspective on the business.
Thank you, Bob. First quarter results were excellent. Sales and revenue were above expectations. Our expenses were in line and our losses lower than expected. Booked sales for the first quarter were $6.8 million, a 44% increase compared to 4.7 million in the first quarter of 2005. K-12 sales increased 48% to $6.3 million from $4.2 million last year. As Bob said, the first quarter is typically the smallest quarter of the year but this was great performance.
We had very Strong results in the Southeast and Great West; all four regions grew. We had 18 sales over $100,000 this quarter compared to 10 last year, and these sales represented about 70% of our business during the quarter, which is at the high end of what we typically see. Last year
© 2006 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial.
the range was 45% to 70% of quarterly results. Average transaction price in this group was about $250,000 which is up from last year but is pretty consistent with our normal experience.
New customer activity was strong. Sales to existing customers were 60% of sales; typically this ranges from 75% to 85%. If you exclude our large sale to Duval County, we were pretty much in our usual range. Services sales were good. K-12 services were 13% of the mix, compared to 11% last year. And sales outside K-12 totaled about $500,000, which was up modestly from last year.
Revenue was better than expected, but declined year-over-year. With the accounting transition to up front revenue recognition on a perpetual license basis essentially complete, we started Q1 with a lower revenue base than last year, $3.8 million this year compared to $6.8 million last year. This shortfall was partially offset by the increase in sales and a higher proportion of our sales dollars being recognized into revenue on an upfront basis. Revenue totaled $7.8 million for the quarter, compared to $10.2 million last year, a decline of 24%.
Product revenue declined 32% to $5.3 million, compared to $7.8 million last year, and this where we saw almost all of the impact from the lower deferred revenue carryover. Service and support revenue totaled $2.5 million, compared to $2.4 million, an increase of 3%. There was some impact on service and support revenue from the lower carryover, but it was modest compared to the product revenue side. We recognized about 59% of this quarter’s sales in revenue, and this is very much at the high end of mix we would normally expect. Revenue was higher than booked sales, so deferred revenue declined by about $1 million.
Gross margins declined in the first quarter compared to the first quarter last year, as expected. Gross margins dropped from 82% to 72% year-over-year, due to a lower proportion of software in the revenue mix and lower service and support margins. Product gross margins are unchanged at 94%. Product revenue was 68% of the total revenue mix in the quarter, compared to 76% last year.
Service and support costs rose 36% year-over-year, and service and support margins declined from 44% to 26%. About one-third of the increase in expenses is from two factors that were not in last year’s first quarter; the implementation of FAS 123R and our national customer conference which was in the second quarter last year. Without these items, service and support costs grew about 23% to support our proactive increase in customer touches and to support our growing sales base.
Operating expenses were in line with our expectations and increased modestly year-over-year. Operating expenses were $8.0 million, compared to $7.2 million last year, an increase of 10%. Excluding FAS 123R expense, operating expenses increased about half that rate. G&A increased only 2%; auditing costs were lower, since we have now cleared our material weakness. The operating loss for the quarter was $2.3 million, compared to an operating profit of $1.2 million last year.
Our net loss was $2.2 million, compared to a net profit of $1.3 million in the first quarter of 2005. The loss per share was $0.13 compared to a profit of $0.08 last year. Because revenue was better than expected and costs were in line, this loss was lower than we anticipated for the quarter
At the end of the quarter, cash and investments totaled $8.2 million, compared to $6.8 million last year. We used $3.9 million in cash from operating activities in the first quarter, compared to $3.5 million last year. This was a little better than our expectations. We are typically cash flow negative in Q1 because it is our lowest seasonal quarter in sales. We also tend to have higher cash spending, to pay year end commissions and bonuses, hold our national sales and service meeting, and it’s also a large quarter for trade shows and marketing.
| | | | |
Thomson StreetEvents | www.streetevents.com | | Contact Us | 8 |
© 2006 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial.
Accounts receivable was $5.2 million at the end of the quarter compared to $3.7 million at the end of the first quarter last year. DSOs at quarter end were 68 days, compared to 70 days last year, and deferred revenue totaled $16 million at quarter end compared to $20.3 million at the end of the first quarter last year. All in all, it was a very good quarter.
During the quarter, we adopted FAS 123R as expected, and the total expense for the quarter was $381,000. This was a little over $0.02 per share. In the first quarter we also adopted a restricted stock unit plan in lieu of options. Since we expect to issue less than half the number of restricted stock units as we formerly granted in options this year, this should reduce our potential dilution and our expected expense. Although we are off to a terrific start to the year, we are not changing our guidance
Sales are expected to be in the range of $38 to $41 million, an increase of 20% to 30% while revenue is expected to be in the range of $36 to $38 million, a decline of 5% to 10%. The decline in revenue is expected to be entirely on the product side, because it was primarily product revenue that was impacted by the changes in upfront accounting. Service and support revenue is expected to increase, reflecting our growing customer base.
Because of the large amount of deferred product revenue that rolled off in the first half of 2005, we expect that total revenue in the second quarter will be below the level of last year and we won’t begin to see positive comparisons until the second half. We expect to recognize about $3.8 million of our deferred revenue balance in the second quarter. This is $2.1 million less than we started Q2 with last year.
We expect a higher proportion of service and support in the revenue mix overall in 2006, and this change in mix will put a couple of points of pressure on overall gross margins. Service and support margins will remain under pressure in second quarter, because Q2 is typically not a big seasonal training period, and we are investing in additional service and support capacity. However, service and support margins are expected to improve in the back half. Because of the seasonal increase in product revenue, the pressure on overall gross margins should be less in Q2 than Q1.
FAS 123R expense is expected to total about $1.7 million for the year. Excluding stock compensation, we expect operating expenses to increase in the mid to high single digits. This expense growth will be driven by continued additions to our sales organizations, increased marketing activity and a more normal level of incentive compensation. Q2 operating expenses should increase seasonally compared to Q1. Reflecting the lower revenue compared to last year and the pick up in FAS 123R expense, we expect to record a loss for the year between $1 and $2 million and a loss per share of $.06 and $0.12.
Excluding FAS 123R, reported results would be in the range of $700,000 profit to a $300,000 loss. Because revenue is expected to be below sales we expect to build $2 to $3 million of deferred revenue during the quarter, excuse me, during the year. We expect cash flow from operating activities to be positive at the high end of our growth targets and modestly negative at the low end. 2006 is the final year of P&L transition from the changes we made in late 2004. In 2007, we expect that sales and revenue growth will be much more closely aligned.
And now, I’d like to turn the call back over to Bob.
|
|
Bob Bowen - -Scientific Learning Corp. - Chairman and CEO |
Thanks, Jane. It was a great quarter for our unique family of Fast ForWord products. Our strong and growing sales pipelines began to produce. Our additional sales capacity is beginning to show results along with our veteran reps getting back on track. All four sales regions produced year-
| | | | |
Thomson StreetEvents | www.streetevents.com | | Contact Us | 9 |
© 2006 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial.
over-year growth with the Southeast and Great West leading the way and the Midwest continuing its strong momentum.
The number of transactions over $100,000 showed an 80% increase over last year’s first quarter. It was an exceptional sales quarter and is encouraging. I will remind you again that this is our smallest sales quarter, and it is a long way to achieving our targeted growth range of 20% to 30%. As Jane indicated, we are not changing our guidance, but I am pleased with the excellent progress we are making toward achieving our strategic and operational goals for the year. We thank you for your continued interest and support for our important work.
And Operator, we will be glad to now take questions.
QUESTION AND ANSWER
Thank you, sir.
[OPERATOR INSTRUCTIONS]
And sir we have a question from the line of Kirsten Edwards from ThinkEquity.
|
|
Kirsten Edwards - ThinkEquity - Analyst |
|
Hi. Congratulations on the quarter. |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
Thanks, Kirsten. |
|
|
Kirsten Edwards - ThinkEquity - Analyst |
|
Jane, can you tell me again the value of deferred revenue recognized in the first quarter, and then what you expect to be recognized in the second quarter? |
|
|
Jane Freeman - Scientific Learning Corp. - Senior VP and CFO |
|
When we started the quarter we expected to pickup - I think it was $3.8 million and that’s essentially what we expect to pickup in the second quarter, that’s our visibility. That’s lower than what we got last year by $1.9 million. We had a bigger deferred revenue base that was rolling off. |
| | | | |
Thomson StreetEvents | www.streetevents.com | | Contact Us | 10 |
© 2006 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial.
|
|
Kirsten Edwards - ThinkEquity - Analyst |
|
Okay, so you recognized $3.8 in the first and the same level is what you expected in the second? |
|
|
Jane Freeman - Scientific Learning Corp. - Senior VP and CFO |
|
That’s right. |
|
Kirsten Edwards - ThinkEquity - Analyst |
|
Okay great. And then Bob maybe you can talk about that -- you have first quarter booked sales growth is very strong, and last year you were talking about a lot of purchases being delayed. Can you quantify how much of that growth was related to delayed purchases in the fourth quarter? |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
Actually it wasn’t that much. I’d say we received only three of those orders that were delayed orders from the fourth quarter of 2005. Those three orders totaled a little over half a million dollars. What happened in most of those cases is that the decision was pushed into the second or the third quarter until they determined whether they could use year end money or they’re going to fund it out of next year’s money. |
|
So, most of those transactions are still in our pipeline. I have to tell you though, we received some orders in the first quarter that we really thought we’d get in the second or in the third quarter. So we did begin to see some of the decisions freed up, but until we see this pattern for a couple of quarters, we’re not willing to say that this cautious environment has gone away. As I stated, the funding environment is better, and we did not see the caution in the first quarter, but we just don’t know for sure what will happen in the second. |
|
|
Kirsten Edwards -ThinkEquity - Analyst |
|
Okay. When you were talking about the environment, last quarter you specifically mentioned Title 1 dollars and the confusion around requirements and the timing of those dollars and that the money paths weren’t moving smoothly. Is that something that’s changed, or is this coming more from IDEA dollars like you had mentioned in your introductory comments, or is it general funding for K-12? |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
Well most of our funding, even in the first quarter, came from Title 1 and Special Ed, and of course some of the states had pushed the release of their Title 1 monies back into February versus releasing that money in November. That was kind of unique to the states, you had to go to the state and look at it. But as you know Title 1 monies, the major portion of it, has to get spent by year end or that money goes back to the state and then goes back to the feds. So what we did begin to see in the first quarter, is school districts saying time is running out and we need to spend that money. |
| | | | |
Thomson StreetEvents | www.streetevents.com | | Contact Us | 11 |
© 2006 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial.
We just hope there’s enough there that they won’t carryover into the second or the third. Now you get the swing about purchasing or when they make their purchases in the second, they either are going to use their year end money to cover that or they can well decide and move purchase into their new monies, but we did see the Title 1 now starting to get released.
|
|
Kirsten Edwards -ThinkEquity - Analyst |
|
Okay great. And in the first quarter I think you mentioned Duval County - the sales to 33 schools was in there? |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
To 15. |
|
|
Kirsten Edwards - ThinkEquity - Analyst |
|
I’m sorry. |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
Remember, we reported in our fourth quarter/year end results that the Duval County Board had approved the purchase of 33 schools and that we would get the first 15 in Q1. We got the first 15 in Q1, and now we expect to get another 18 in time for them to open school in August. We anticipate the purchase of the additional 18 schools coming in June or July. |
|
|
Kirsten Edwards - ThinkEquity - Analyst |
|
Okay and then lastly, can you give us a number of orders over 800,000? I think that’s the metric you’ve given us in the past? |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
We had one order over $800,000 and that was the Duval County award. |
|
|
Kirsten Edwards - ThinkEquity - - Analyst |
|
Right okay. |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
And that point I was making to you is that one of the things we’ve really tried to do is to make sure that we are taking orders off the table as quickly as possible rather than trying to upsize |
| | | | |
Thomson StreetEvents | www.streetevents.com | | Contact Us | 12 |
© 2006 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial.
|
them and to get them into these mega deals. So most of our $100,000+ purchases were in the $100,000 to $300,000 range, however, we did have one order with Duval County over $800,000. |
|
|
Kirsten Edwards - ThinkEquity - Analyst |
|
Great. Okay. Thanks a lot. |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
Thanks, Kirsten. |
|
|
Operator |
|
[OPERATOR INSTRUCTIONS] |
|
And sir we have another question from the line of Kirsten Edwards. |
|
|
Kirsten Edwards - ThinkEquity - Analyst |
|
I thought I’d ask another one since there’s time. I think last call you’d mentioned that you’re investing in R&D to try to reduce the protocol below the 50 minute level. |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
That’s correct. |
|
|
Kirsten Edwards - ThinkEquity - - Analyst |
|
Do you have any update on that progress or outlook? |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
Well, the only thing I would say is that our scientists are encouraged from some of the early data. And let me talk about the encouragement from two perspectives. One of the things we’re looking very closely at is exactly what students do as they move through a protocol or a day, and we believe through efficiency that has taken out some of the, what we call the brain relief periods in there. And some of the techniques or feeding information back to the students was not really exercise related. We’re pretty confident that we’re going to be able to get the [time] improved below the 50 minute protocol. |
|
The question is can we go all the way to get the protocol down to the 30 minutes? So I’d say the scientists are more positive about getting Fast ForWord to Reading in that range. They’re more concerned about the sound intensive exercises found in Fast ForWord Language, but they’re working away, and we’re hopeful because it would be another barrier if we could do that. |
| | | | |
Thomson StreetEvents | www.streetevents.com | | Contact Us | 13 |
© 2006 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial.
|
|
Kirsten Edwards - ThinkEquity - Analyst |
|
Great okay. Thanks, that’s all. |
|
|
Operator |
|
[OPERATOR INSTRUCTIONS] |
|
And sir we have no further questions at this time. |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
Let’s wait just one second and see if there’s any other questions before we get off. |
|
|
Operator |
|
[OPERATOR INSTRUCTIONS] |
|
And sir we have no questions at this time. |
|
|
Bob Bowen - Scientific Learning Corp. - Chairman and CEO |
|
Okay. Well thank you, very much. And just to let everyone know that Jane and I will be available if you have additional questions either later today or tomorrow. Please let us know. Thank you. |
|
|
Operator |
|
Ladies and gentlemen, we thank you for your participation in today’s conference. This concludes your presentation, and you may now disconnect. Good day. |
| | | | |
Thomson StreetEvents | www.streetevents.com | | Contact Us | 14 |
© 2006 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial.
|
DISCLAIMER |
|
Thomson Financial reserves the right to make changes to documents, content, or other information on this web site without obligation to notify any person of such changes. |
|
In the conference calls upon which Event Transcripts are based, companies may make projections or other forward-looking statements regarding a variety of items. Such forward-looking statements are based upon current expectations and involve risks and uncertainties. Actual results may differ materially from those stated in any forward-looking statement based on a number of important factors and risks, which are more specifically identified in the companies’ most recent SEC filings. Although the companies may indicate and believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate or incorrect and, therefore, there can be no assurance that the results contemplated in the forward-looking statements will be realized. |
|
THE INFORMATION CONTAINED IN EVENT TRANSCRIPTS IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES THOMSON FINANCIAL OR THE APPLICABLE COMPANY OR THE APPLICABLE COMPANY ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY EVENT TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. |
|
© 2005, Thomson StreetEvents All Rights Reserved. |
| | | | |
Thomson StreetEvents | www.streetevents.com | | Contact Us | 15 |
© 2006 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial.
Scientific Learning Corporation
Supplemental Information
Reconciliation of Booked Sales, Revenue and Change in Deferred Revenue
| | | | | | | | | | | | | | | | |
$s in thousands | | | | | |
| | First Quarter | | Year Ended December 31, | |
| |
| |
| |
| | 2005 | | 2006 | | 2005 | | 2006 Estimated Range | |
| |
| |
| |
| |
| |
Booked Sales | | $ | 4,727 | | $ | 6,784 | | $ | 31,538 | | $ | 38,000 | | $ | 41,000 | |
Less Revenue | | | 10,245 | | | 7,831 | | | 40,319 | | | 36,000 | | | 38,000 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net (Decrease) increase in current and long-term deferred | | $ | (5,518 | ) | $ | (1,047 | ) | $ | (8,781 | ) | $ | 2,000 | | $ | 3,000 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | |
Beginning balance in current and long-term deferred | | | 25,784 | | | 17,003 | | | 25,784 | | | 17,003 | | | 17,003 | |
Ending balance in current and long-term deferred | | $ | 20,266 | | $ | 15,956 | | $ | 17,003 | | $ | 19,003 | | $ | 20,003 | |
Booked sales is a non-GAAP financial measure that we believe to be a useful measure of the current level of business activity both for management and for investors. Booked sales equals the total value (net of allowances) of software and services invoiced in the period. Because a significant portion of our revenue is recognized over a period of months, booked sales is a better indicator of current activity. The table above shows the reconciliation of booked sales, revenue, and changes in deferred revenue.
The information included above for the 2006 full year is a projection, subject to the safe harbor created by Section 27A of the federal securities law. This projection is subject to substantial risks and uncertainties. Actual results may differ materially as a result of many factors, including but not limited to: general economic conditions; the extent of acceptance and purchase of the Company’s products by target customers; seasonality and sales cycles in Scientific Learning’s markets; competition; availability of funding to purchase the Company’s products and generally available to schools; the extent to which the Company’s marketing, sales and implementation strategies are successful; the Company’s ability to continue to demonstrate the efficacy of its products, which depends on how the programs are administered, the demography of participants and other factors; the Company’s ability to recruit and retain key personnel; the Company’s ability to timely execute its new product development strategies; pricing pressures; and other risks detailed in the Company’s SEC reports.
May 11, 2006
