International Business Machines Corp (IBM) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Corio second quarter 2004 earnings conference call.

[OPERATOR INSTRUCTIONS].

I would now like to turn today's conference over to our host, Mr. Brett White.

Please go ahead.

Thank you, operator.

Hello and thank you everyone, for joining us to discuss Corio's second quarter fiscal 2004 financial results, which are for the period ended June 30, 2004.

If you do not yet have a copy of today's press release, please feel free to go to our web site at www.corio.com where it is presently posted.

On the call with me today, is George Kadifa, Chairman and CEO of Corio.

George will report on our financial results and, review our business performance and, I'll discuss the financial results in more detail and provide financial guidance for the third quarter 2004.

George will come back with closing remarks and, then we'll open up the caller questions.

First, I would like to preface the 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 could cause actual results to differ materially from those expressed or implied by such statements.

For example, we are including as part of this conference call a discussion of targets for the financial and, business performance of Corio for the second half of 2004 to 2005, among numerous other forward-looking statements.

All of these discussions constitute forward-looking statements, regarding future events or future financial performance of the company.

The actual results could differ materially from those expressed and, implied by the forward-looking statements.

The risks and uncertainties that could cause actual results to differ from those expressed or, implied by forward-looking statements 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 statements on forms S1 and S3, its prospectus, its quarterly reports on form 10-Q and its annual report on form 10-K.

You should refer to those risk factors and, evaluate any of these forward-looking statements.

The company assumes no obligation to provide the outlook information that we are providing today.

And, with that, I'll turn it over to George.

Thank you Brett and, welcome everyone.

Today, I am pleased to update you on four key topics.

First, our solid Q2 performance which met or, exceeded the guidance we provided you 90 days ago.

Two, is the demand momentum for our offerings.

Three, are the projection for the rest of 2004 and the year 2005.

And, four, our operational achievements and plans.

First, regarding our Q2 performance, revenues were $17.7 million, which well exceeded the upper range of the guidance of 16.4 to 17.2 million and, grew 4% over last year's Q2 2003 revenues of 17.1 million.

Our bookings in Q2 continue to be strong.

We closed about 80 transactions this quarter, winning nine new customers, as well as achieving major bookings within our customer base.

EBITDA was a negative 1.4 million within the middle of the guidance range.

We delivered the largest number of customer activations in company's history in Q2, as well as, we reached the largest number of customers in the company's history too.

And, we finally achieved the strongest sales opportunities the pipeline for Q3 and Q4-quarters ahead of us.

Second, our demand momentum continues to be strong.

We are approaching the $100 million level of total contract value booked, since demand momentum picked up in the second half of last year.

We expect that we will reach such level this quarter.

These bookings cover new customers, renewals of current customers, as well as add-ons from the install base.

In addition, our pipeline has further strengthened and, doubled in size from last year.

These results show excellent returns, from our investments in sales and marketing and, confirm the continued adoption of our Applications on Demand platform and services model.

For Q3, as you know, we have the challenge of replacing the revenue from our largest customer Expanets, due to its acquisition by Avaya last November, which accounted for 12% of our total revenues last year.

This customer will be terminating their services with us by the end of this month, since they have finished their cut over to the systems of their new parent company.

We have worked hard in Q2 to address such revenue hits and, we have succeeded in doing so.

We expect revenue to slightly drop in Q3 from Q2 while absorbing the $650,000 per month revenue loss from Expanets / Avaya but, to pick up again in Q4, to a level near or, about Q2 hence totally replacing the loss of Expanets on the revenue line in 90 days.

We expect our Q3 revenues to range between 16.5 and, 17.2 million and, our Q4 revenues to range between 17 and $17.8 million.

These projections show that our organic revenues, beyond Expanets, are expected to grow by a quarterly sequential rate of about 4% in Q3 or, about 15% on an annual basis and, for Q4 we expect the growth numbers to be double-Q3 reaching an annual growth rate close to 30%.

Note that the above revenue projections, have very minimal settlement fees.

There are two potentially large settlements that we are still managing with large percent in Avaya, that can result in significant revenue in the next two to three quarters.

We are able to achieve the above rapid recovery based on two areas of strength for Corio, continued demand momentum and, a strong customer base.

As mentioned above, the demand for our services remains very strong and, we expect it to remain so in the foreseeable future.

In addition, our current customer base is solid, diversified and, offers a strong basis for our continued growth momentum.

Going forward into Q3, our customer base enjoys the following advantages: about 126 total customers, with 112, being application management services customers.

Servicing about a quarter of a million business users for such customers, about 40% of the installed base revenue comes from Fortune 500 companies, about 60% of installed base revenue comes from companies with more than $1 billion in revenues.

Our customer base gross margin on an ongoing basis is projected at 25 to 30%. 66% of the installed base has done additional add-on business with us and going forward, no customer accounts for more than 5% of our total revenue and, our top ten customers account for less than 30% of our revenues.

We are increasing the focus of customer satisfaction and, account penetration with such a strong customer base and, look forward to continuing to augment such base, with seven to ten new customers every quarter going forward.

Third, operationally, we have performed about 100 customer projects, activated about 200 environments for current and new customers, managed more than 100 terabytes of storage and processed 20,000 service requests.

And, we did so while developing high levels of availability, security and response time.

In operational support, we are undertaking three major programs that will result in increased investment expenses for Q3 and Q4.

One is the activation of new contracts.

Two is infrastructure consolidation.

And, three is Sarbanes-Oxley compliance.

And following are more details: the first program is the ongoing activations and, the migrations of new customers and, new contracts into Corio's operational platform.

Such investment expenses, are primarily in equipment and labor, to bring such customers to full production status.

Last quarter, we activated about 200 environments and, we will do at least the same amount this quarter.

The expenses for such investment are taken as incurred than upfront, while the revenues are recognized throughout the turn of the contract.

Our single customer economics model, shows that such upfront expenses are recouped within the first year of contract and, then customer gross margins increase significantly thereafter.

We estimate that we spend between $1 to $2 million per quarter, in these activities, depending on the complexity of the solutions being implemented.

In addition, we have taken a decision to streamline our data center operations and, to upgrade our internal network for IP technology.

We have finished the major phase of our internal network upgrade and, we expect to save 30% on our current network expenses as a result.

In addition, we will be consolidating the six main data centers we currently operate in, down to two or three.

We are planning to consolidate one data center by the end of August and, two in Q4.

Such streamlining is starting to increase our operation flexibility, lower our cost and, have a completely consistent delivery model for our customers and, our delivery organization.

We estimate that we'll spend about $500,000 in Q3 and, $200,000 in Q4 for such consolidation.

We expect that good levels of savings will start to be realized in Q4 and, more in Q1 next year.

The third program is compliance to Section 404 of Sarbanes-Oxley, that we are working to achieve by the end of this year.

Significant activities have already been done in process documentation.

Follow on working, testing and remediation will be carried through.

This is mainly a one-time event, to perform the initial compliance work and, we expect our cost related to this effort to decrease next year.

We estimate that the total cost of such program is about $1 million.

We are accounting for the first two of such investment expenses as cost of goods sold and, the third one as G&A expense.

Based on the investment expenses of the above three programs and, the loss of Expanets, we expect EBITDA to be in the range of minus 2.7 to minus 3 million in Q3, decreasing to minus 1.8 to minus 2.5 million in Q4.

We expect to reach quarterly profitability in 2005, where we project annual revenue to grow by 16% to 23% ranging from $81 million to $86 million for the whole year.

We are targeting to end the year with run rate of about $100 million in revenues.

We have reviewed a variety of scenarios that can allow us to reduce our expenses in Q3 and Q4.

However, based on the opportunities in front of us and, our plan for 2005 we believe that such investments are appropriate, we will continue supporting our current demand momentum, will lower our operating expenses, and will constitute an outstanding 2005 performance.

Retrenching at this juncture, was judged as inopportune.

We can afford such investments today and, we can see the opportunities for such returns in the next 180 days.

Fourth, we are continuing to add to our intellectual capital and technologies.

In the next 30 to 45 days, we'll be releasing version 4.0 of our I-service operational platform.

New automations, self-service web services, provisioning and more reporting will be provided.

This will be the industry leading operational platform for application management.

We have 18 customers who have signed up for our beta program and, will be rolling out this release to our remaining customers thereafter.

From a product offering perspective, we're planning a major launch for new offerings in the September time frame.

Such new offerings would be structured into an applications on-demand wave that is unique in the industry and, will cover on-demand products and services that will deepen the scope of our current offerings and, offer us new opportunities to service our customers currently and for future prospects.

With that, I'll now turn the call over to Brett for the detailed financials.

Thanks, George.

As George mentioned, we're very excited today to review with you our financials and, accomplishments for the second quarter and, outlook for the future.

Total revenue for the second quarter was 17.7 million, which is up slightly from last quarter and, a 4% increase from the same quarter last year and exceeded guidance that we gave you three months ago.

Excluding impact of non-recurring customer settlement fees, total revenue increased 4% sequentially from last quarter.

Applications management revenue was $13.8 million for the second quarter.

This second quarter number includes non recurring customer settlement fees of approximately 0.4 million, versus approximately 1 million last quarter.

Professional services revenue was 3.9 million for the second quarter, a 44% sequential increase from Q1.

Total cost of revenue expenses, which include applications management services and, professional services are 14.9 million, resulting in a total gross margin for the second quarter of 16%, compared to 22% last quarter.

The cost of applications management services revenue for Q2 was 11.6 million, up approximately 0.2 million from last quarter and, resulting in a gross margin of 16%, compared to 24% last quarter.

Three percentage points of the decrease, in applications management gross margin, is attributable to the lower settlement fees in Q2 versus Q1.

The cost of professional services was 3.3 million in Q2 '04, up approximately a million or, 83% of the incremental revenue from last quarter, resulting in a gross margin of 14% compared to 12% last quarter.

Indirect operating expenses, which include research and development, sales and marketing, and general administrative in total, were 6.2 million for the second quarter.

R&D expense was approximately 0.5 million in the second quarter and approximately in line with the prior quarter.

Sales and marketing costs were 2.7 million, also in line with the prior quarter and.

June 30th we had 11 quota carrying reps.

G&A expense was 2.9 million for the second quarter, an increase of 28% from the prior quarter.

During Q2, we incurred increased audit and professional fees, primarily associated with Sarbanes-Oxley compliance and, expect these costs to continue through the rest of the year and then tail off next year.

In earnings, our GAAP loss for Q2 was 3.8 million or, $0.06 per diluted share and, our EBITDA loss, which is earnings before interest, tax, depreciation and amortization, for Q2 was 1.4 million, which is within the guidance range we gave you 3 months ago.

On the balance sheet, we finished the second quarter with $41.6 million in cash, cash equivalents, short-term investments and restricted cash.

And, operating cash flow with was a use of 2.5 million.

In Q2, we drew down on the remaining 3.1 million of our 7 million equipment credit line to finance new customer activations and, our data center consolidation project.

Days sales outstanding was 40 days, versus 30 days in the prior quarter.

The increase is primarily due to the 44% increase in professional services revenue during the quarter.

Professional services revenue bills in arrears, versus applications management services revenue, which is generally billed in advance.

We're targeting DSO in the mid 30s going forward.

We have 346 employees, on board at the end of the second quarter, which is a net increase of 20 employees from last quarter.

Included in this number are 82 employees in our Bangalore, India office.

Our MRR, monthly recurring revenue was approximately 42,000 in the quarter.

Our total revenue mix, by product was PeopleSoft approximately 32%, Oracle approximately 28%, SAP approximately 27%, and Siebel and other applications making up the remaining 13%.

We have nine new customers, six of them applications management services customers and, three of them professional services customers.

On the guidance, as we have disclosed in our previous earnings call and our SEC filings, our contract with Expanets / Avaya ends July 31, 2004.

The revenue from this contract was 650K per month, so the impact on Q3 '04 revenue will be a decrease in 1.3 million in applications management revenue, for this customer alone compared to Q2.

Since this contract has been in place for several years, it was in its most profitable phase.

So, the direct costs associated with this contract, that will be eliminated at July 31, 2004, are approximately 10% of the monthly revenue.

Although there are settlement fees due, under this contract, they are still under negotiation so, we don't know the precise value and timing of these fees.

These fees are accounted for on a cash basis method.

As a result, we have not included any of these settlement fees in our revenues forecasts going forward.

We expect total revenue in Q3 '04 to be in the $16.5 to $17.2 million range.

The middle of this range represents an approximately 4% sequential revenue growth, from Q2 when adjusted for the impact of settlement fees and the impact of Avaya.

We expect settlement fees in Q3, '04 to be approximately 400,000.

We expect increased G&A costs through the Sarbanes-Oxley compliant and, as George mentioned, we expect EBITDA in Q3 to be in the range of 2.7 to $3 million negative.

With that, I'll return the call to George for closing comments and Q&A.

The first half of the year has shown a good demand momentum.

We intend to continue to build on such momentum, for the rest of the year and well into 2005.

We see the market environment and, the demand in that market environment that has gotten firmer and, decision-making is more predictable, especially for the services we deliver and for the Applications on Demand platform and delivery model.

Although we have seen recent weakness in the software sector, we don't expect that such weakness will have any negative impact on us but, could be advantageous for our customers and ourselves.

Within this positive environment, we did have a disappointment in losing our largest customer.

For reasons totally unrelated to our value proposition.

We have a plan in place, to address the short-term impact of such loss.

We expect to recover the revenue in 90 days and, expenses in 180 days.

We believe we have succeeded in addressing such impact, while maintaining forward momentum of our business.

We will maintain the cash strategy we have deployed successfully in sales and marketing, as well as, in service delivery, technology development and product introductions.

There are four key drivers that keep supporting us in achieving success.

One, is demand momentum for our value proposition.

Two, our strong and diversified customer base.

Three, our unique on demand delivery model.

And four, our products and technology.

We have a large opportunity in front of us, and we intend to take it.

In conclusion, I would like to take this time to thank the contribution of our customers and partners, as well as, the efforts of our Corio employees.

And with that, I would like to turn the call over to the operator for questions.

Thank you.

[OPERATOR INSTRUCTIONS].

Our first question is from the line of John Torrey with Adams, Harkness & Hill.

Please go ahead with your question.

Hi, guys.

Two questions for you.

George, in the $100 million in contract value that you alluded to in your earlier comments, how much of that roughly in percentage terms or dollars is attributable to renewals?

I don't have that data in front of me, but Brett what is your estimate?

Less than a third, probably.

Let's just look at the numbers very quickly for you, John.

All right.

Yes, it should be less than a third, maybe less than 30% also.

OK.

And, with respect to the guidance for I guess Q3 and Q4, what is the assumed AMS mix in those ranges that you've given, roughly?

For which period?

Q3 and Q4.

I think for Q3, we think consulting revenue will be basically flat.

Maybe you know, we'll call it 3.5 to 4, and then I'd say about the same mix in Q4.

I think consulting revenue is going to grow a bit in Q4, so maybe it's 4.5 or so.

Consulting is 4.5?

Yes, probably.

OK.

Can you -- with respect to Q2 bookings, can you provide some further information on the balance between new customer bookings and existing customer bookings, excluding renewals?

Yes.

I think we might have that data too.

Do you have that?

I'm sorry, what is the question?

For Q2 bookings, can you add a little bit more information on the balance of bookings between new customers and existing customers, excluding renewals?

And, compare that perhaps to Q1?

I think, frankly, it doesn't matter, John, because they're all reflect into revenue increases.

But, if I - you know the rule of thumb roughly is 40/60. 40 is new, 60 is add-on.

We have taken that over a broader range.

Right.

And generally, to your earlier point, about a third or, less of the 60% associated with existing customers is attributable to renewals.

Is that fair?

No.

That's after -- if you take the renewals out.

Got it.

OK.

Brett, I think you said in your comments what the operating cash flow for the quarter was.

I just missed it, could you --?

A use of 2.5.

OK.

I'll leave it at that for now.

Thanks.

Thanks, John.

Our next question is from the line of Mike Crawford with B. Riley.

Please go ahead with your question.

Can you just go into a little bit more detail on some of the new contracts?

So, you said there were 8 new customers during the quarter.

How many dropped off and, what was the final customer count?

The final customer count, as you mentioned - yes, 126 and I think there were two customers who did not renew.

Just the straight math, is that's 9 adds and one leave, I think is the math from last quarter.

It was one, not two?

Yes, I think so.

OK.

And, then is there any way to further quantify the expenses associated with ramping up and, activating these new contracts before you start to recognize the revenue?

And also, what is the typical duration of these new contracts?

The typical duration of the new contracts are roughly three years.

We have had contracts you know for new customers that were five years also.

But on average, it's three.

It's hard to give you an exact number about the activities, in terms of cost, that is why we give you a range of $1 to $2 million per quarter, because it really depends on the complexity of the solution we're implementing.

So, that is 1 to 2 million depending on if you are activating seven to ten new accounts?

No.

Depending, you know, we have for example one account, like the SAK, which is a small company, where the activation process wasn't that exhaustive, versus an add-on business, with, let's say, a company like American Express that consists of the data center moves.

So, it's not one to one in term of number of accounts, versus cost numbers.

OK.

And, then I can't remember if you disclosed this before, but what was the time remaining on the Expanets contract?

That is for Q3, and what Brett mentioned here there was one more month left.

That was the scheduled end of the contract?.

Oh, you're talking about the contractual end?

Yes.

No.

That's the termination notice.

Right.

He's talking about how much was left contractually on the contract.

I'll tell you.

About -- it went through '06, so a couple of years.

OK.

Great.

Thank you.

And John, if you're still on the line, you asked about what was the consulting assumption in Q4 revenue guidance.

I said 4.5.

Use 4.5 to 5 as your high to low, if you're still on.

Thank you.

Our next question is from the line of Eric Swergo with Grouber McDane (ph).

Please go ahead with your question.

Good afternoon and thanks for providing more detailed forward guidance, than you have in the past.

Unfortunately, I couldn't write quickly enough.

Your '05 guidance for revenue was low to mid teens? 81 to 86 million, and did you give EBITDA or earnings guidance for '05?

No.

All we said was we would reach quarterly profitability in '05.

Yes, the range is 81 to 86 million.

You know, at this stage, we haven't provided our EBIT our specific EBITDA by quarter.

Let us say if you reach profitability, quarterly profitability in '05, does that mean EBITDA profitability, earnings profitability, and if so, in what quarter are you expecting that crossover?

Again, Eric, this is like a year from today, so we can't give you something solid.

What happened there?

Hello?

I don't know what that was, sir.

OK.

So, the current plan is to basically focus on EBITDA profitability first for the first half of the year.

And followed by, you know, improvement to reach the second target if possible by the second half of the year.

OK.

Thank you.

There are no further questions at this time.

Please continue.

OK.

Well, thank you very much and we look forward to be with you 90 days from now.

Thank you.

Thank you, ladies and gentlemen.

That does conclude our conference for today.

Thank you for your participation, and for using AT&T executive teleconference.

You may now disconnect.