After reporting lower guidance for the third quarter on September 14, EZEN traded down sharply and, with a recent bounce, is now valued at 4.6x 2005 and estimated 2006 trailing EBITDA and 7.7x 2005 and 2006 (untaxed) earnings.  The company has significant net cash, a large NOL, predictable cash flows, strong organic growth (until this year) and minimal capital needs.  Management’s guidance is for flat to slightly higher revenues and earnings this year, based on slower sales and renewals in the third quarter, which management attributed to (i) Department of Defense (DoD) budgetary constraints before the government’s October 31 fiscal year end, which they expect to improve as the government moves into the 2007 year, (ii) investment by the company in building its sales force, an investment it expects to begin paying off in 2007, and (iii) increased competition from a competitive product.

 

Ezenia! develops and sells communication and collaboration software, primarily to the U.S. Department of Defense, which currently comprises over 90% of its business.  Through its flagship InfoWorkspace product, the company provides for communication between military personnel on the battlefield and tactical command personnel at the Pentagon.  The general objective of the product is to simulate the experience of a face-to-face meeting.  Basically, the product allows a battlefield commander to have video, voice and/or audio conferences with generals around the world, sharing any type of documents simultaneously on all screens, communicating through voice or instant messaging, and recording every aspect of the communication.

 

The company’s sales strategy is based on building strong relationships with DoD decision makers.  EZEN partners with large government contractors such as General Dynamics or Northrop Grumman, and often packages its product within these larger government contracts.  Upon releasing InfoWorkspace 3.0 earlier this year, the latest generation of the company’s flagship product, EZEN has added to its sales force, with the objective of expanding its customer base to include other government agencies such as the Dept. of Education, Dept. of Justice or Dept. of Homeland Security. 

 

The company derives the largest portion of its revenues (approximately 85% of total revenues for six months ended 6/30/06) through the sale of 12 month software licenses to its customers, which provide the customer with use of its product for the term of the license.  Upon booking a sale, the company books a deferred revenue liability, and it recognizes the revenue equally over the applicable 12 month period.  This provides visibility into the company’s revenue base, particularly after the company’s 1^st and 3^rd quarters, which have historically been the largest quarters in terms of new bookings.  Other revenues are derived from training and from customization of the product to meet specific customer needs.

 

EZEN had been a high flyer in the 1990s, selling a video conferencing product to the business market.  After demand for this product tapered off, the board of directors brought in Khoa Nguyen as its President and CEO in April 1998.  Nguyen had worked in R&D for IBM for many years and had held executive positions in the videoconferencing industry at both PictureTel Corporation and VTEL Corporation.  Nguyen engineered the company’s move out of the videoconferencing business (other than a small legacy component that remains today), and took the company into the defense space with the purchase of the InfoWorkSpace product from General Dynamics in March 2001 for $18 million.  The company has built the business from almost scratch in 2001.

On September 14, EZEN lowered its guidance for the third quarter ended September 30.  Management cited government budgetary pressures and, to a lesser extent, competition from Adobe’s Breeze product as the main causes of the soft quarter.  The company added that its revenues from sales of software licenses would be flat with those of Q2, but that service revenues would be down by $500-600K from Q2.  The company’s renewal rate had also declined in the quarter, from approximately 80-85% historically to 75-80% in the quarter.

 

Management has expressed the view that some of the renewals have been pushed out beyond the October 31 government fiscal year end, which would cause some of the business lost in Q3 to be recovered in Q4.  Additionally, management indicated that a large training contract would be announced very soon, which would further bolster revenues in Q4.

The company defines its marketplace as software for the real time collaboration market.  Because its products are targeted primarily for the government, it does not have any pure competitors, in that no other company operates with this as its primary line of business.  The company believes that no other product in the market has its mix of features, including instant messaging, voice/video communication and real-time sharing and recording of information, and that it has the largest market share within the DoD for collaboration software, and an exclusive position for battlefield related applications.

 

At the current stock price of $1.90, EZEN’s total market cap is $28 million.  We estimate it currently has $12 million of cash.  Thus, it trades at 4.6x 2005 and estimated 2006 EBITDA on an EV basis and 7.7x trailing EPS.  LTM multiples are actually lower, but we are not using them.  The company has had excellent performance over the past several years.  From 2003-2005, the company has grown its top line by 94%, and has improved from an EBITDA loss in 2003, to 17% EBITDA margins in 2004 and 27% EBITDA margins in 2005.  It has continued to improve its operating leverage in 2006, with another 400 basis point margin improvement in the six months ended 6/30/06.  More impressively, all of its growth has been organic and has been accomplished with negligible capital investment in the business.  This has allowed the company to accumulate its sizeable cash balance.  Additionally, as of the end of last year, the company’s federal and tax NOL’s stood at approximately $53 million.  With the company currently generating less than $4MM of pre-tax income, it will not pay taxes for many years.

 

Because EZEN operates in a niche business environment, there is a dearth of pure public comparables; however, the closest public peers are WebEx Communications, Inc. (Nasdaq:  WEBX) and Radiovision Ltd. (Nasdaq:  RVSN), both of which trade at 15x-16x trailing EBITDA.  Additionally, in April 2006, Raindance Communications, Inc., which also operates in a similar space to that of EZEN, was sold to West Corp. at a valuation of approximately 9x EBITDA.

 

We believe a 6-8x EBITDA multiple is reasonable, and if the company regains operating momentum, it could go much higher.  A 6-8x EBITDA would lead to a stock price of $2.50 - $3.50 by the end of 2007.  The company actually traded as high as $3.70 earlier this year.  In addition, at the current price and current earnings level, the company’s cash balance will continue to grow by $3-4 million annually, a FCF return of 11-14%.  By the end of 2007, the company should have $15-17MM of cash.

 

The following chart outlines the company’s potential share price using different EBITDA and multiple assumptions.

 

2007 EBITDA ($ millions)			$    3.5	$    3.5		$    4.0	$    4.0		$    4.5	$    4.5
Multiple			6.0x	8.0x		6.0x	8.0x		6.0x	8.0x
TEV			21.0	28.0		24.0	32.0		27.0	36.0
Cash			16.0	16.0		16.0	16.0		16.0	16.0
Equity Value			37.0	44.0		40.0	48.0		43.0	52.0
Shares O/S			14.6	14.6		14.6	14.6		14.6	14.6
Price Per Share			$  2.53	$  3.00		$  2.73	$  3.28		$  2.94	$  3.55

The company has not been paying a dividend or actively repurchasing stock.  Management has indicated that an acquisition of good strategic fit may be an option, although the management team appears very focused on continuing to grow the business and would be very selective on the acquisition front. 

 

As mentioned earlier, the company derives most of its business from the sale of 12 month software licenses to its customers, and these revenues are realized evenly over the course of the year.  This has the effect of providing a reasonable level of earnings visibility. More importantly, the company’s historical renewal rates have been in the 85% range, which should have the effect of precluding sharp downturns in the business.

Despite recent lumpiness in the government’s spending cycle, management remains bullish on the outlook for the business going forward.  With the recent release of InfoWorkspace 3.0, management is continuing to hire sales reps, with a target of 8 or 9 sales reps by the end of the year (as compared with 3 at the beginning of the year).  Management intends to use 2 of these sales reps to focus entirely on expansion into other government agencies, which would both accelerate the company’s revenue growth and diversify its customer base.  One possible area of expansion is the homeland security space.  Such aggressive expansion of the sales force, particularly with a focus on growth into new markets, is a strong indication from the management team that the business is ripe for robust growth.

 

Catalysts

Adoption of 3.0 Product / Potential for Non-DoD Sales

 

The company believes the 3.0 upgrade will take 2-3 years.  As it proceeds, it will stimulate growing ancillary revenues.  Additionally, management believes that its new product is very flexible, and intends to introduce 3.0 to a new universe of customers, particularly other government agencies.  Winning a non-defense contract would certainly be a strong catalyst for the stock.

Resumption in Booking Activities

 

The company expects to see an improvement in bookings in Q4 as the DoD enters its 2007 fiscal year on November 1.  Additionally, with the ramp-up of the sales force in recent months, there is the potential for growth in revenues as new salespeople gain traction and become productive.

 

Increased Investor Attention

 

The company is currently not exchange listed and has no equity research coverage.  With the hiring of a CFO 6 months ago, the company has become more investor friendly.  Previously, the CEO also served as CFO of the company and did not return our phone calls.  The CFO has been more responsive and gave us a meeting last week.  At some point in the future, the company may do more proactive IR.

 

Risks

·        Continued budget pressures causing softness in DoD IT purchases and declines in renewals

·        Competition from a prime defense contractor (such as General Dynamics or Northrop Grumman) launching new product that competes with InfoWorkSpace

·        Limited DoD market opportunity given finite number of DoD personnel worldwide, 25% of whom have some form of communication and collaboration software

·        Competition from Adobe’s Breeze product or from the collaboration software in Microsoft Outlook 2007