SWK Holdings Corp (SWKH) 2002 Q2 法說會逐字稿

Good day everyone and welcome to the KANA Software 2Q financial results conference call. Today's call is being recorded. For opening remarks and introductions I would like to turn the call over to the CEO, Mr. Chuck Bay. Please go ahead, sir.

Thank you. Hi, this is Chuck. I am here with John Huyett, our CFO. I hope you all have received a copy of our press release and before we start going through the discussion of our June quarter John has a statement that he'd like to make.

Thanks Chuck, and good afternoon everyone. If you have seen our press release you know that our results were in line with the previously announced expectations except for a non-operational, non-cash charge, which reduced the amount of goodwill on our balance sheet from approximately $63m to approximately $8m. If you have not seen a copy of our press release you can get one from our website at kana.com.

Our conference call today will consist of two parts, first our prepared remarks and then q-and-a. But first I want to caution you about some of the forward looking statements that you will hear on today's call. On this call we will make forward looking statements regarding anticipated events and the future performance of the company including statements regarding our expected revenues expenses, profitability, cash flow, margins, operating results, EBIDTA loss, our goodwill impairment charge, particular long term implementation projects, our long term success, product development, and characteristics of our market segment. Actual events or results could differ materially from those described or anticipated in these forward looking statements as a result of a number of factors including risks associated with the effect of economic trends and uncertainties, competition, market acceptance of our products, retention of employees, changes in KANA's market capitalization, ongoing negotiations regarding the referenced implementation project, and other factors described in our most recent filings with the SEC, including our most recent reports on form 10-Q and 10-K.

In addition, I want to emphasize that these forward looking statements are based on judgments and that individual judgments may vary. Our company policy is to provide guidance once per quarter and we do not plan to update that guidance or any other forward looking statements until the next scheduled call. The forward looking statements in this call speak only as of today and no one should assume later in the quarter that comments we provide today are still valid. Now I will turn the call back over to Chuck.

OK. Although certainly the economic environment was tough last quarter KANA had many highlights during the quarter. We continue to make progress with our integrator partners and the leverage that they bring us. We have booked some very good deals. We have a very strong sales pipeline. We continue to see success internationally in Europe and Asia. We have continued to build and improve our sales teams around the world and we continue to build our lead with respect to products and technology in the market. Now we talked about our GE contract on our call three weeks ago. As you will recall we accrued a significant loss on a contract under which KANA was bound to act as prime contractor on a very large $24m deal. The deal was signed on a fixed fee basis prior to the KANA/Broadbase merger and the cost overruns associated with this contract that caused us to take this accrual. This clearly ruined our 2Q operating results. We believe that we have accrued everything we should ever need to with respect to this deal and we remain committed to making implementation successful for GE. We do not anticipate that there will be any significant cash flow implications resulting from this deal. We have already made the cash investments required to resolve the outstanding issues with GE and Tom Doyle has been working non-stop on this matter and I am very confident that the bad news is behind us.

This quarter we closed deals with IBM, with Accenture, with CSC, and with KPMG and in fact all of our deals are done with integrators. As most of you are aware, KANA is a software company, we are not half software company and half integrators. Many companies in our space continue to replace license revenue with professional services revenue and this continues to help solidify and expand KANA's integrator relationships. Our partners who live in this tough economic environment are acutely aware of the fact that in the CRM space only KANA cooperates instead of competes with integrators. All of our integrators increased the number of KANA trained people this quarter and all have reiterated their alliance commitment to KANA, as the eCRM vendor of choice.

Turn to some of the deals that we booked. In Telco we booked a $4.5m license with Sprint. This deal was for in excess of 10,000 seats of our knowledge application. In Tech we booked a $2.5m license with Dell. This deal was for in excess of 5,000 seats, again of the knowledge application. In fact, our average deal size remains well above $0.5m, in line with last quarter and we continue to focus on getting the average deal size above $1m. Just this week we closed a deal for a license over $1m with a Fortune 100 company on the east coast. This deal was with KPMG acting as integrator. I believe in addition we have already closed four other deals this quarter.

Now I particularly [indiscernible] the close is very tough in this environment. In this environment CFO's of large organizations are holding PO's and elongating approval processes. However, because our deals are always in association with integrators the odds of a deal going away are usually quite slim. We closed many deals in Europe and Asia this quarter. We worked primarily with IBM in Asia and in Europe we worked primarily with IBM, Accenture, and KPMG. Our pipeline of deals for the coming three quarters is strong.

As I've noted, forecasting exactly when a deal will close is very tough. However, we have gotten very good at identifying deals that KANA will win. As our integrators can attest, if a deal is primarily driven by the telephone requirements in a call center then virtually all these deals go to Siebel or PeopleSoft. But, if a deal involves creating a web-driven call center/contact center or moving service to the web or using powerful knowledge management applications to reduce service costs, in those cases we seldom see any competition at all.

This becomes pretty clear when you look at the fact that even the telephone companies continue to remain a strong market for KANA and they are awfully good at squeezing the cost of a customer support call down to a minimum. They know they need to move services to the web and they and their trusted integrators know that this means KANA solutions.

We have continued to build our elite sales force. Tom Doyle has already converted the sales force from a $2.5m quota per year machine and is phasing into a mode of $5m a quarter per rep. By January 1 every rep at KANA will have been phased into the $5m quota. Obviously this reduces the cost of sales and marketing because fewer reps are required to drive significant levels of license revenue and this is possible because of the strong support we have from our integrators. Deals can take a bit longer to close when an integrator is jointly driving the deal but the deals tend to be larger and more certain to close when integrators are jointly driving them.

Our clear lead in products and technology is getting even better. We have a release in a few weeks of our response application. This release is focused upon internationalization and we expect it will do especially well in Asia. We have been working closely with IBM and Accenture on this release.

It's been almost exactly one year since the KANA/Broadbase merger was closed. In that year we have established KANA as the eCRM leader in number of customers, number of seats, integrator partners, and most, most importantly in products. The companies throughout CRM are searching for product strategies as the economy continues to tighten. But KANA's strategy remains clear. KANA enables large organizations to move customer service from expensive telephone centric modes into a mode of responding to customer needs and requests over the web and in blended phone and web modes. This saves companies money and this makes KANA the eCRM leader.

I'll turn to John and he can talk about some of the financial highlights for the quarter.

Thanks Chuck. First I want to touch base on the goodwill adjustment that I talked about. After our July 2 preannouncement our stock declined quite a bit and that required that we assess the value of goodwill that's included on our balance sheet. And based on that calculation we wrote down goodwill by $55m in 2Q. Again, this is a non-cash charge and it's non- operational and it may change in fact if there are further indications of a decline in value. Any change uh, if there is a change at all it will be reflected on our forthcoming 10-Q for the quarter ended June 30.

But to summarize our operating results, our revenues were $17.2m. We had a GAAP net loss of $3.76 per share based on roughly 22.8m shares outstanding. Our EBIDTA loss is $1.06 per share. And later on in our guidance discussion I will also refer to EBIDTA.

Let me now discuss some more details regarding our financial metrics. Revenue for the quarter was roughly 50/50 between license and service. And this is pretty strong for our industry and we expect that to even improve as we go forward. Importantly consulting service revenue represented only $1.3m, or only 7-8% of our total revenue. Our outsourced service strategy continues to pay off. During Q2 we continued to see extremely strong renewals with $7.6m of our service dollars being generated from maintenance. With over 1300 customers worldwide, KANA's large installed customer base provides us with a significant maintenance stream as well as license opportunities.

Sales this quarter were primarily derived from North America - 80%, with international contributing approximately 20%, with Europe as the primary contributor. As always a strong financial indicator for us is the repeat business from our existing customer base and for Q2 about 64% of our license booking in dollars were generated from existing customers. License margins were in excess of 87% with service margins at roughly 52%, excluding the impact of the $18.7m charge for the long-term project. Partner influenced revenue was once again 100% consistent with our strategy and for our quarters.

Moving over to the balance sheet, cash and cash equivalents, that is unrestricted cash, at the end of June was $47m, which was ahead of plan. The change from Q1 reflects the use of approximately $6m in capital expenditures offset by a $2m release of an escrow account related to the long term project and cash outflow from operations including payment of accrued merger and restructuring charges, was less than $1m.

Our [DSL's] for the quarter were 96 days, which is higher than our historical average. Another overall objective we have set is to cut our [DSL's] in half by the end of next year, primarily by building backlog and improving our visibility.

Deferred revenue at June 30 was $26.9m, an increase of 10% from $24.4m in 1Q. Our deferred revenue is more than 1.5 times our last quarter's revenue and the composition of the deferred revenue between license and maintenance; the license portion is giving a more significant portion of our deferred revenue.

Moving to headcount, our fulltime headcount today is around 400, which is down 25 since March 31, since the end of the first quarter. At the close of each quarter our standard procedure is to eliminate unproductive sales reps. Any reps that we don't expect to be able to carry the fullblown $5m quota next year were let go. We eliminated 12 reps after the close of the second quarter and are now at 34, down from 46 last quarter. However, we are rehiring. We are hiring sales reps and we are always looking for seasoned sales people, particularly ones that have years of experience in dealing with large integrators.

This takes me to our guidance. Looking ahead to 3Q and 4Q, we don't believe it is prudent for us to foresee the market improving in the near term. However, assuming that the current market conditions do not change, we believe that 3Q will be roughly in line with 2Q revenues but our EBITDA per share will improve to only $0.09-0.11 per share.

Returning to profitability as a key objective, and we are committed to reach breakeven as soon as possible, based on our current projections, KANA's EBITDA breakeven can be accomplished on a revenue run rate of approximately $20- 21m, which we believe is in ... within reach. That, based on the current market environment, our backlog, and our current projections we are targeting to reach cash flow positive from operations and positive EBITDA in 4Q02. We are also targeting to become overall cash flow positive in 1Q03. With our current cash resources excluding restricted cash, we expect our low point of cash to be at least ... no worse than $35m at any time. This concludes the financial highlights. I will turn the call back to Chuck for his concluding remarks and q- and-a.

Yes, I think we have got a lot of people who want to ask questions. I would just add a reminder that as all of you know, KANA management values backlog and visibility very dearly and we feel good today about both backlog and visibility. We have worked very hard to close very large deals. We do not take the bulk of the revenue on those deals when they are closed and that gives us good visibility and it gives us a good backlog position. We continue to have a very strong pipeline of very large deals with the integrators and we are very confident in the numbers that John was just talking about. So operator let's move to question mode.

Thank you. If you would like to ask a question please press the star key followed by the digit one on your touchtone phone. Once again, if you'd like to ask a question please press the star key followed by the digit one. We will pause a moment to assemble our question roster. We go first to Ryan Rathman with Morgan Stanley.

Hey guys, a little bit about, you know, you signed the Sprint deal, the Dell deal, talk a little bit about, I think you said something in the last conference call about the timing of when you will see those revenues hit the P&L and then, you know, you were talking about kind of going after these bigger deals which is, you know, definitely noted in the sense that, you know, Doyle has been doing $5m quotas next year but you know, what are the sales [indiscernible] looking like on these longer deals with these larger deals?

On a ... the strategy that Tom has, the reason he is moving to $5m [indiscernible] deals and we have already closed one. That was the BTCellnet deal with IBM. We have more with IBM. Those deals we typically put aside when we do our forecast. We still do a lot of $0.5m deals, a lot of $400,000 deals, $600,000 deals, so I don't want people to believe that we are only chasing the elephants. But the integrators chase elephants and they do the bulk of the heavy lifting there and they help us. In fact, IBM is absolutely instrumental in closing the big deals with us. I will let John address how we recognize revenue on large deals. Let's say a large deal for John's purpose of how we recognize revenues is over $1m.

Specifically to the Sprint and Dell deals, the majority of the revenue on those deals can be recognized in 3Q02 and 4Q02. On the large deals, you know, revenue recognition is as you know very complicated but under the large deals with the integrators there are typically milestones or payment streams or both that are laid out in the future and we don't recognize revenue until all the contingencies are gone and the payment is due.

OK, you know, now one follow-up question, so you know going into the current quarter that we are in, you know, how much of the quarter do you feel that you kind of already had booked because of, you know, the status of the Sprint and the Dell deals and does the flagged item kind of suggest that you are seeing pressure on signing some of the or a greater number of the smaller deals that you referred to earlier?

No I think the guidance reflects the fact that although we feel very good about the September numbers we would like to start feeling a lot better about the December and March numbers. And, uh ... so we are going to be conservative with respect to September and then we'll let our bookings come in and in the first week of October we'll have a lot more to say about December and March.

Alright. Thanks.

We take our next question from Cameron Steele, RBC Capital Markets.

Thanks. Uh, Chuck I guess one of the trends that we are seeing out there is that no one is doing big deals any more but here you guys are talking about doing large transactions and doing more of them. Can you talk about maybe why that's happening, um ... why you guys are able to uh, why you guys are focusing on this and what's allowing you to do this when other vendors who have typically done this kind of thing are not doing it anymore?

Well the primary reason is that our software, a year ago we saw what we thought was a trend in very large organizations with millions of customers needing a way to save money in communicating with their customers. That's what drove the KANA/Broadbase merger and we got out ahead of the curve and so now here we are in one of the toughest economic times and companies with millions of customers uniformly have to find ways to cut budgets so that their CFO's can get on calls and meet EPS targets. Our integrators are the key to the whole equation. Somewhere, way before the KANA rep gets in a room, the Customer Support VP and the CIO sit down and say what are we going to do. We've got a mandate to save money. They either trust IBM or they trust Accenture or KPMG or CSC or D&T and those partners know to say, well if you are trying to squeeze a phone call let's talk to Siebel or PeopleSoft. If you are trying to move stuff to the web we have KANA and nobody else has come in as a strong competitor to KANA in this space and then what you are seeing now is it's starting to play out. And we think this is just the very beginning. The pipelines that we have with the integrators indicate that this trend is going to go on for quite a long time.

Great. Thanks.

Once again if you'd like to ask a question please press the star key followed by the digit one on your touchtone phone. We go to Pat [Mason], Pacific Growth Equities. Mr. [Mason] your line is open.

[Derek Wood]: Oh, sorry I was on mute. This is [Derek Wood] for Pat. I'm wondering if you could comment on your product suite and which specific products are being best received by your customers and which ones are selling through the best.

Sure. Um, you have to divide deals into two categories: one mammoth deal. Mammoth deals are always contact center driven. That is the historic Sylknet product. Those deals will typically involve the entire product suite and will price above $5m, always integrator jointly driven.

On the deals that we do most often it would be split between deals for the knowledge application, which for those of you who have tracked us a long time is an historic service [indiscernible] product. We maintain the development groups in Manchester, New Hampshire and Framingham, Massachusetts because we are putting a lot of money and time into these products. Again a lot of times the IQ product will be bundled with the email product response.

The only product that we don't see increasing demand for is the marketing application. As everyone knows, marketing went away. Every company the first expense you cut in a tough environment is marketing. People are not buying many marketing applications although we did close three marketing deals last quarter. We had not forecasted those deals. Those came in upside and largely came in in Europe. So US it is a rare deal in the marketing space. Most of the companies we see in the marketing space are just doing integrator service deals. They have turned themselves from software companies into integrators hoping to just weather out the storm. Uh, we have no intention of doing that. We'll maintain a software stance and internationally cross our fingers. Maybe marketing will come back soon.

[Derek Wood]: OK. Thank you.

There are no further questions at this time. I would like to turn the call back over to Mr. Bay for any additional closing comments.

In closing thanks for listening in and if anyone needs to reach us, send us an email.

That concludes today's conference call. Thank you for your participation. You may now disconnect.