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Operator
Good day everyone, and welcome to this Corio Inc.
Q2 2003 conference call.
Today's call is being recorded.
At this time for opening remarks and introductions I will turn the call over to Senior Vice President of Corporate Development and Investor Relations, Mr. Arthur Chiang.
Please go ahead sir.
Arthur Chiang - Senior VP Corporate Development and Investor Relations
Thank you operator.
Hello and thank you for joining us to discuss Corio's second quarter of fiscal 2003 financial results which is for the period ended June 30, 2003.
If you do not have a copy of today's press release, please feel free to go to the Corio website at www.corio.com where it is presently posted.
I am here today with George Kadifa, President and CEO of Corio, and Brett White, CFO, both of whom will be addressing you shortly.
George will report our financial results and take you through our business from the last quarter.
Then we'll discuss our financial results in more detail and provide financial guidance.
George will come back for some closing remarks, and then we'll open the call up for questions.
First I'd like to preface this discussion with our Safe Harbor Statement.
All forward-looking statements made during the course of this conference call are subject to known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied by such statements.
We are including as part of this conference call, discussion of targets for the financial performance of Corio for the third quarter 2003 as well as the fiscal year 2003.
All of this discussion constitutes forward-looking statements regarding future events, or future financial performance of the company.
There are some uncertainties that could cause actual results to differ from those expressed or implied by forward-looking statements, which include, but are not limited to the risk factors noted in the company's filings with the Securities and Exchange Commission, including the company's registration statement on Form S1, its Prospectus, its quarterly reports on Form 10Q, and annual reports on Form 10K.
The company assumes no obligation to update the outlook information that we are providing today.
And with that I'll turn the call over to George.
George Kadifa - President and CEO
Thank you Arthur, and welcome everyone.
I would like to characterize the second quarter as one of very solid execution by the Corio team on a number of fronts.
To start with, I would like to mention first, our solid financial performance.
We have exceeded our revenue guidance.
We provided you last quarter with the guidance of $15.5m to $16.5m in revenues.
We actually reached $17.1m in revenues for Q2.
We have also exceeded our cost reduction guidance.
As you recall last quarter, we guided you for an additional $1m of cost savings from our Q1 numbers.
Actually, we were able to reduce our operating expenses by $1.7m versus $1m goal.
And we did that while we actually increased headcount.
We invested in Corio India, and we kept our investment levels from a research and development perspective.
And we also have accomplished a positive EBITDA for the second quarter in a row.
So, here we are for the second quarter producing positive EBITDA.
And the last piece from the financial performance perspective is we have exceeded our cash performance guidance, and we reached a third quarter of positive operating cash flow.
In addition to the solid financial performance we are showing that our business is scaling, and is scaling quite nicely.
One is, we have more than 150,000 subscribed users on our platform.
We are actually, across all of our product lines, are able today to scale across the customer base; and we believe that we can even scale higher in that regard.
At the same time we're applying [inaudible] automation technologies and we've been able to increase the quality of our service while simultaneously reducing the expense to deliver such service.
And the third piece, we're doing all these components while at the same time expanding our operations offshore and maintaining a very significant R&D budget investment through it.
With that I would like to turn the call over to Brett to provide us with the detailed financials; and then I'll come back to you, and I'll make comments on the market and the competition.
Brett?
Brett White - CFO
Thanks George.
Good afternoon everyone.
As you can probably tell we're very excited to share with you our financial results, and accomplishments for the second quarter, as well as our outlook for the third quarter.
The second quarter was really terrific.
Revenue was $17.1m in total, which is a 43% increase from last year.
Applications management revenue was $14.8m and 87% of total revenue.
This represents a 65% increase from last year, and includes $500,000 of non-recurring settlement fees, which is the same as last quarter.
On the expense front, total cost of revenue expenses, which includes application management services and professional services, were $13.6m, which was a decrease of $1.6m or 12% from the prior quarter.
This decrease includes the realized benefits from negotiated vendor contracts, and the implementation of the initial phases of our offshore strategy.
Gross margin for the second quarter was 20%.
The cost of application management services revenue in the second quarter was $11.9m, which was a decrease of $1.3m or 10% from the prior quarter.
Applications management services had a gross margin of 20%.
The cost of professional services was $1.7m in the second quarter.
This was a decrease of $300,000 or 15% from the prior quarter.
Professional services had a gross margin of 23%, which is a healthy improvement off of a 15% gross margin last quarter.
Indirect operating expense which includes R&D, sales and marketing, and G&A all net of amortization, in total were $5.5m for the second quarter, which is a decrease of 7% from the prior quarter.
Research and development expense was $1.35m in the second quarter and that was flat compared to Q1.
We had a net addition of 8 headcount in R&D in the quarter.
Sales and marketing costs net of amortization were $2m in the second quarter compared to $2.1m in the prior quarter.
As of June 30th, we had 10 quota carrying reps.
G&A expense was $2.2m in the second quarter, a decrease of 8% from $2.4m in the prior quarter.
On the earnings front, our GAAP loss in Q2 narrowed to $3m, or .05 cents per diluted share which is a decrease of $4.8m or 62% from last year.
EBITDA, which is earnings before interest, taxes, depreciation, amortization in the second quarter, was a positive $800,000.
Onto the balance sheet.
We finished the second quarter with $47.1m in cash, cash equivalents, short-term investments and restricted cash and generated positive operating cash flow of $.1m.
This is the third quarter in a row of positive operating cash flow.
Our DSO was 16 days.
Hard to believe an improvement from the 19 days last quarter.
Our collections people are just doing an outstanding job here, and we're seeing a lot of success on collecting; and, therefore, cash flow.
We're continuing to target DSO in the 30-35 day, but I certainly am happy with where it is now.
We had 287 employees on board at the end of the second quarter which is a net increase of 5 employees from the prior quarter.
On to guidance.
In Q3 '03, we expect to show year-on-year revenue growth of approximately 10% or more.
We also expect to see continued improvement in our operating efficiency and further leverage from the expansion of Corio India, and expenses to decrease again in Q3 in addition to the impressive cost reductions already realized in Q1 and Q2.
As we discussed in our last couple of calls, there were customer contracts acquired from Quest in September '02 that we knew were in the process of transitioning out.
We have wrapped up the significant known transition customers in Q2, and we believe that Q3 will represent our revenue baseline going forward.
The expected impact of transition customers were reflected in the full year's revenue guidance that we gave in our January '03 conference call.
Our guidance for Q3 - we believe revenue will be between $14.5 and $15.5m.
We expect total expenses to decrease approximately $1m from Q2 to Q3 which includes the expansion investment costs associated with Corio India that we expect to incur in Q3.
We expect about half of this $1m reduction to be amortization.
With that I'll return the call to George for his closing comments and Q&A.
George?
George Kadifa - President and CEO
Thanks Brett.
To conclude, I would like first to cover the demand side.
I just want to let you know that this quarter is starting to look very good.
We had a very strong July month.
We haven't ended the month yet, but so far it's looking quite good.
And our pipeline today looks-it's the strongest pipeline we've had since the dotcom era.
On the competitive side, we basically today do not see other ASPs or software vendors as competitors any more.
Our win rate against these entities has been very, very high.
Our current competition, we see it with large integrators, and typically with companies with 'three letter words.'
From a partner perspective, we're starting to see traction with partners.
And we had situations where partners have brought us deals.
And finally I'm very pleased with the customer satisfaction performance we've achieved so far.
As you all know, we have quarterly customer satisfaction surveys.
Q2 has indicated it's one of the highest, if not the highest customer satisfaction quarters we ever had.
And frankly when you look at our DSOs which are 16 days today, it's a reflection of customer satisfaction.
As Brett keeps reminding me, happy customers pay on time.
With that, we're very pleased with Corio's performance in the second quarter.
I would like to thank, to take the time right now to thank the contributions of our customers, our partners and also all the efforts of the Corio employees.
With that I would like to turn the call over to the operator for questions.
Operator
Thank you Mr. Kadifa.
If you do have a question or a comment you would like to ask, you may signal us by pressing (*) followed by the digit (1) on your touchtone telephone.
Again, you may press (*) (1) if you have a question or a comment.
We'll take your questions in the order that you signal us.
We'll take as many questions as time permits.
Again that's (*) (1), and we'll pause for just one moment.
And we'll take our first question from Kim Chen [ph] with B Riley and Company.
Kim Chen - Analyst
Hi George, hi Brett.
George Kadifa - President and CEO
Hi.
Kim Chen - Analyst
I'm actually calling in for Mike Crawford.
I have a couple of questions.
Could you talk about your reduction in bandwidth cost, especially in the application management services; and what would you expect going forward?
George Kadifa - President and CEO
Brett would you answer that?
I presume, the way you're asking this, you're looking at the cost of goods sold for our application management service revenue line, is that correct?
Kim Chen - Analyst
Yes.
Brett White - CFO
A reduction in bandwidth cost, is that what you said?
Kim Chen - Analyst
Yes.
Brett White - CFO
Yes, we've had some pretty significant reductions there.
We're actually seeing cost reduction both on the bandwidth side but actually probably more importantly on the whole data centre cost side, we've been able to renegotiate some contracts, make better utilization of actually square footage.
Since the company is so much larger now than it was a year ago, we're able to get more leverage off of that side in our negotiations.
So, we've seen quite a bit of reduction there.
That's a major piece of the reductions you've seen off of AMS, our application services business, over the last couple of quarters.
We think that there's still room to improve there, although not near the levels of improvement we've seen over the last couple of quarters.
Kim Chen - Analyst
Okay, thanks.
And also one more question.
Could you comment on your partnership channel?
And what percent of your revenue is attributed to the partnerships?
George Kadifa - President and CEO
Let me take that question.
The way we look at it is more as percent of bookings instead of revenue, because the revenue, to us, has been carried from past contracts.
In terms of bookings, we're seeing at least a 30% contribution from our partners because of new bookings.
Kim Chen - Analyst
Okay, and are there any new vertical categories you guys are focusing on?
George Kadifa - President and CEO
Not specifically, no.
Kim Chen - Analyst
No, okay.
And, last question.
Previously you said that 20% gross margin is sustainable.
What would you like to see your gross margin at two years from now?
George Kadifa - President and CEO
Okay, let me-before I answer that question-actually we have a specific focus on the government vertical that we would focus more on right now.
And then, on the last one, in terms of your question, the gross margin, Brett, I hope we can expect more than 20%, correct?
Brett White - CFO
Yes, obviously as we continue to bring costs down, as we start driving revenue, gross margins expand.
I don't really want to estimate future gross margins in this forum, but needless to say there's lots of opportunity to grow that number.
Kim Chen - Analyst
Okay, thank you.
George Kadifa - President and CEO
You're welcome.
Operator
And we'll take our next question from Peter Schlider [ph] with Peninsula Capital.
Peter Schlider - Analyst
Yes, first of all, great quarter, showing a lot of progress.
I'm curious which of the ERP partners you saw give you the best growth on a bookings basis, or just kind of a general flavour more around what's going on behind the bookings in this application management services area.
George Kadifa - President and CEO
In terms of the partners, I don't have that data specifically.
But we've been seeing across the board, progress across all of them.
I do not have from a bookings perspective a specific number that way.
Brett, any additional data?
Brett White - CFO
No, not really.
Peter Schlider - Analyst
And then in terms of the cost reductions that you took out of the business quarter to quarter.
I'm assuming almost all of that is, or a predominance of it is the move to India.
Is that pretty accurate?
George Kadifa - President and CEO
No, not at all, actually.
Peter Schlider - Analyst
Okay, good.
George Kadifa - President and CEO
India has been actually a net add in our expenses so far.
Brett White - CFO
Right.
George Kadifa - President and CEO
Because we just established the subsidiary about 6 months ago and we've been basically investing in that element.
What you're seeing here Peter, is frankly the fruits of the R&D work we've been doing.
In the last areas we've done work in increasing the returns on our assets, be it servers, or storage, or tape backup, or archiving, etc.
So there's a lot of stuff we've done in that domain.
We're also working hard in terms of leveraging the data centre and services around those data centres.
And also, there's an overall level of discipline in the company with systems that we have around it, that allow us to be much smarter in how we execute on transactions.
Peter Schlider - Analyst
Okay, well that's interesting.
Listening to that response, what kind of capacity do you think you have right now in terms of numbers of subscribers, or however you want to measure it, to expand?
Before you have to start to really add to CAPEX.
And what was CAPEX in the quarter?
George Kadifa - President and CEO
Brett do you have the CAPEX number?
Brett White - CFO
Yes, it was about-the cash flow statement will show, I think, around $900,000, but it was about $1.4m in total.
Peter Schlider - Analyst
Okay.
George Kadifa - President and CEO
And in term of scaling, we do believe that there is room to scale in terms of capacity from where we are today.
Peter Schlider - Analyst
But not give us a sense of when you really have to spend money to increase that capacity.
George Kadifa - President and CEO
I'm very comfortable with, on the short-term, to have, to show that we have enough capacity in the areas that we're going after.
I do not foresee any major investment in the millions of dollars we have to do either way.
The only area where we might need to add capital, typically, is if we end up winning large customers, situations where as part of that customer contract we have to purchase some equipment specific to that contract.
But that would be good news in that regard.
Brett White - CFO
And all the contracts have equipment finance built into them so the customer simply pays for the hardware and it just passes through us.
Peter Schlider - Analyst
Okay.
Well, great job, thank you.
George Kadifa - President and CEO
Thanks Pete.
Operator
And I would like to remind our audience that it is (*) (1) if you do have a question or a comment.
Next we'll hear from Trevor Kolby [ph] with RBC Bain Rusher [ph].
Trevor Kolby - Analyst
Yes, could you give me a, you did some revenue guidance and you said you were going to lower your expenses for Q3 down about $1m.
Do you have a GAAP EPS estimate for Q3, or a range that you could give us?
Brett White - CFO
No, I'm not guiding to that.
That requires that I just get into all the buckets, so I just give you revenue and total costs, and you can probably make a pretty fair shot of it.
Of the million dollars, half of it is going to be amortization, I think.
And that should get you there.
Trevor Kolby - Analyst
Okay.
And, should we be focusing at all on cash basis, like last quarter you had $16.6m of ASP revenue, and like, $6m was on a cash basis.
And this year was- or this quarter was $14.8m?
Brett White - CFO
Right.
Trevor Kolby - Analyst
Are you gong to give a breakout for this quarter as well?
Brett White - CFO
For cash basis?
Trevor Kolby - Analyst
Yes.
Brett White - CFO
Yes, it will be in our Q. The number for AMS cash basis is about $4.9m.
So on a percentage basis it's slightly down, it's about 29% versus 32% last quarter.
Trevor Kolby - Analyst
Okay.
Brett White - CFO
And obviously that helps DSO.
Trevor Kolby - Analyst
Right.
All right, thank you.
Operator
And once again I would like to remind our audience that it is (*) (1) if you have a question or a comment.
And we'll hear next from Clark Neeman [ph] with Logos Partners [ph].
Clark Neeman - Analyst
Oh, hi George.
I had a question.
You guys voted to effect a reverse stock split and I don't see any voter, or discussion about what's happening with that.
George Kadifa - President and CEO
At this stage it's a non-issue.
Brett White - CFO
Right.
Clark Neeman - Analyst
What do you mean it's a non-issue?
The board voted for a reverse stock split?
And then, did you put on a case that that, that you're not pursing that?
George Kadifa - President and CEO
The board voted for a reverse stock split about-
Clark Neeman - Analyst
November of last year.
George Kadifa - President and CEO
Right.
And we voted on that based on the situation with our NASDAQ listing.
And about the opportunity for us to maintain that listing.
At this stage, there is no issue in that regard, and we have not, from a board perspective, maintained that item on the agenda.
Clark Neeman - Analyst
Why don't you put a piece-why don't you-huh-I'm sure you spent some money on your lawyers pursuing that.
Why wouldn't you just announce that that's a-you've halted all of that discussion.
George Kadifa - President and CEO
We'll take that into consideration, Clark.
Clark Neeman - Analyst
Well, okay.
I'm not against that, by the way, pursuit of that.
George Kadifa - President and CEO
Okay, well thank you for sharing your perspective.
Operator
And one final reminder for our audience, that is (*) (1) if you'd like take a question or have a comment.
And gentlemen it appears there are no further questions.
Mr. Kadifa, I'll hand the conference back to you for any closing comments.
George Kadifa - President and CEO
Well, I would like again to thank everyone, especially our customers, our partners and our employees, and we're looking forward to talking to you in 90 days.
Thank you.
Operator
And that does conclude today's conference.
We thank everyone for their participation.
We hope you have great day.