SWK Holdings Corp (SWKH) 2002 Q4 法說會逐字稿

Good day, everyone, and welcome to the KANA Software fourth quarter 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 chief executive officer, Mr. Chuck Bay. Please go ahead.

Thanks. Hi, this is Chuck. I'm joined on this call by John Huyett, our CFO. I hope that you've all had an opportunity to review our press release this afternoon.

But before we start the discussion of the December quarter, John has a brief statement he would like to make.

Thanks, Chuck, and good afternoon, everyone.

If you have seen our press release, you will know we had a very good quarter. If you haven't seen a copy of it yet, you can get one from our website at kana.com.

Before we begin our prepared remarks 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, EBITDA, our long-term success, product development, and characteristics of our market segments. 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 competition, including introductions of new products or services by our competitors, reductions in prices, lack of market acceptance of KANA's products or services, inability to enhance or develop our products and services within budget and on schedule, inability to attract and retain qualified employees, to manage cash and expenditures, or to expand sales, inability to manage our business in light of recent personnel reductions, KANA's history of losses, the effect of potential military action and terrorist activities, and slow economic conditions, particularly as they effect spending by our prospective customers on ECRM and similar enterprise software products.

These and other factors described in our most recent filings with the SEC, including our most recent reports on Form 10-Q and 10-K are risks associated with our business that may affect our operating results. 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 on this call speak only as of today and no one should assume later in the quarter the comments we provide today are still valid.

Now I'll turn the call back over to Chuck.

Thanks, John.

As you can see from our press release today, KANA had a very nice fourth quarter. Our license revenue grew. Our total revenue grew. Our cash balances came in well ahead of target. Our gross margin again came in above 80%. We exceeded our goal of getting to EBITDA break even and in fact, showed an EBITDA profit for the quarter. We were able to renegotiate our last significant ease liability for unused space in Q4 and this resulted in not only a significant cash savings for KANA, but also produced a small GAAP profit for the quarter.

John will explain more about these financial metrics in a minute. Although certainly the general economic environment remained difficult through the quarter, we were able to perform well. Our sales pipelines grew. And again this quarter, 100 percent of our deals were integrator assisted. We have deals ongoing with IBM, with Accenture, with BearingPoint and also with our newest top-tier integrator partner, Business Edge. We also have deals in the pipeline with CSC, EDS and Deloitte Consulting.

This quarter, we reached a new milestone within the Fortune 100. KANA now has 52 of the Fortune 100 companies as customers. We see demand for our products within the largest companies in the world and these companies recognize the importance of leveraging the Web for customer service and communication, and they recognize that KANA is the leading CRM company in providing the products that enable this leverage.

Our integrator partners continue to build their KANA practices and continue to train additional people for installing KANA applications for their clients. These integrators tell us that one of the key reasons for our success is the fact that they can demonstrate for their clients that KANA products produce rapid return on investment. Demonstrable return on investment is a significant advantage for KANA, and our integrator partners use that advantage as they proactively help us close deals.

In Q4, we closed deals in the telecommunications sector, in the financial services sector, in the government sector, and in the consumer goods sector. In each of these sectors, the common thread for success seemed to be KANA's close partnerships with our integrator partners and our combined ability to deliver cost savings. Fortune 500 CFO's continue to closely scrutinize spending and they closely scrutinize ROI claims. The sales trends are not changing, and we don't see things getting easy in the near future. Although most CRM companies continue to search for strategies and for product positioning to use in these challenging times, KANA's strategy remains clear and seems to be succeeding, as you can see from our Q4 results.

Our customer service applications continued to dominate our bookings in Q4. Our marketing and analytic applications remain at roughly 10% of our business, as they have been for the past four or five quarters. The competitive landscape has not changed significantly over the past quarter and KANA remains focused upon enabling our customers to move away from expensive telephone-centric customer support models and into the blended use of phone and Web based support and communication.

Our ability to support J2EE, EJV, .net, and NT platforms positions us uniquely as the ECRM (ph) leader and continues to improve our levels of integrator support. Tom Doyle and his sales teams have done a great job this quarter. The managers in the field continue to build their elite sales forces. The average quota for salespeople has again increased this quarter and I believe that you will see substantive improvements in our profitability as we realize the productivity gains from these increased quotas.

We are very proud of the fact at KANA that we continue to put successive quarters of financial progress together. And as we move into a position of generating cash instead of burning cash, our clear remaining goal is GAAP profitability on a quarterly basis.

I can tell you that we firmly intend to reach this goal this year, 2003.

Now let's turn to John for more insight into the Q4 financials.

Thanks, Chuck.

First we will review the income statement and then the balance sheet, followed by Q1 and 2003 guidance. In terms of earnings, I'll break down our performance into three different snapshots, GAAP, EBITDA and pro-forma. As you will see, all three exceeded expectations. All per-share data that I mention is based on our fully diluted weighted average shares outstanding, which were 22,898,000. On a GAAP basis, EPS came in at a positive 1 cent per share.

As described in our press release, this includes a one time benefit of $5.1 million related to the net reduction of previously accrued excess facility costs. We filed the Form 8K on November 21 that described these cost settings in detail. But briefly, we were able to restructure an existing lease such that that our minimum future rent obligation has been reduced by approximately $500,000 of cash outlay per quarter.

As you may recall, last quarter, our guidance going into Q4 was for break even EBITDA. EBITDA in the fourth quarter was $5.4 million or 24 cent per share. Even if you exclude the $5 million benefit, we exceeded this goal during the quarter and reached one penny positive EBITDA per share.

We can examine our earnings performance relative to first call analysts consensus, which excludes one-time charges or benefits, as well as non-cash items like amortization of intangibles and stock-based compensation. In the old days we used to called this pro-forma earnings. On a pro-forma basis, that is, if you calculate EPS by excluding two line items on our income statement, amortization and the restructuring costs, our pro-forma EPS is a loss of 9 cents per share, 2 cents better than the first call consensus on December 31.

In case you haven't heard, thankfully, the SEC has issued their final rules on the use of non-GAAP financial measures on February 23rd. These rules restrict pro-forma reporting but do allow reporting of EBITDA. Accordingly, we're asking the Wall Street analysts to base their future models on EBITDA.

I will give guidance on our expected amortization and depreciation later in the call.

Now some details -- revenue totaled $18.7 million in the quarter, up 4% from $18 million in the third quarter. License revenue increased sequentially by 6% to $9.3 million compared to $8.7 million in the third quarter. Importantly, license revenue grew 9% year over year. I'm particularly pleased with this year over year license growth. Once again, software license revenue accounted for nearly half of total revenue, and combined software license and software maintenance accounted for 91% of total revenue leading to very high gross margins, which I'll describe later.

In the fourth quarter, 73% of our revenue was from North America, with 27% coming from Europe and Asia. Our strongest verticals were telecom and financial services. Roughly 20% of license revenue came from new customers. New customers included Hutchinson, 3G, Philips, Telus Communications, Daimler-Chrysler in the U.S., Velex, Nissan in the state of Ohio.

Our maintenance renewal rate continues to hover around 90%, which is a great affirmation of the value of our software. With over 900 active customers worldwide, our large installed customer base provides us with a significant maintenance stream as well as new license opportunities. Significant new license wins with existing customers include Citigroup, the Pay Pal division of eBay, BellSouth and Verizon.

As we have been evangelizing, KANA is a software company and not an integrator. Once again, as Chuck mentioned, 100% of new deals were partner influenced. Our partners appreciate the fact that we work with them and do not compete with them. This also reduces our cost of sales and marketing efforts because fewer reps are required to drive significant levels of license revenue. Experienced partners also help insure rapid successful deployments.

Our gross margin in Q4 was $15.2 million or 81% of total revenue, consistent with last quarter's gross margin of 82%. This compares to gross margins of 75% in the year-ago period, which was when our integrated partnering strategy was just beginning to take hold.

Once again, we were able to reduce ongoing operating expenses. We reduced operating expenses by over 6% compared to the third quarter. Sales and marketing expenses were $8 million or 43% of revenue, compared to 48% of revenue in the third quarter. R&D was 34% of revenue, or $6.4 million dollars, the same as in the prior quarter. During our last call, I told you we were committed to reducing our G&A overhead and I'm pleased to report that we did. G&A expenses were reduced by over 14% from three and a half million to just under $3 million.

Moving over to the balance sheet, cash and cash equivalents, excluding restricted cash at the end of December was $32.5 million, giving us a solid level of liquidity for the foreseeable future. During the quarter we used approximately $1 million on capital expenditures and $1.5 million on operations. We reduced total liabilities by $13 million during the quarter. Accounts payable are $3.9 million, down from $7.1 million at September 30 and $11.6 million at June 30th.

Our quick ratio, defined as free cash and investments plus net receivables divided by accounts payable, accrued liabilities and current notes payable, is better than 2 to 1. Working capital excluding deferred revenue is more than $18 million. DSOs (ph) at December 31 were 49 days, which I believe is an all-time record low for the company, that's down substantially from 96 days at June 30 and 61 days at September 30.

Looking forward we will continue to work to reduce DSO's. Deferred revenue on December 31 was $26.4 million, about 1.4 times quarterly revenue. Our full time head count today is around 360, and our revenue per employee increased for the second quarter in a row.

This takes me to our guidance. Looking ahead to the first quarter and full year 2003, we don't believe it's prudent for us to foresee the market improving in the near term assuming that the current market conditions do not change. We believe that Q1 revenues will be roughly in line with Q4 revenues. And for Q1, EBITDA is expected to be roughly in line with Q4 results, excluding the net reduction of the previously accrued facility costs of $5.1 million.

For the full year of 2003, our revenues are targeted at between $75 and $85 million. Our depreciation is budgeted at approximately $2.6 million per quarter. Amortization of intangibles and deferred stock compensation is estimated as follows -- Q1 approximately $3.2 million, Q2 approximately $2 million, Q3 approximately $1.6 million, Q4 approximately $1.5 million. EBITDA is expected to be between $7 to $9 million for the year. Based on these assumptions, we expect to be cash flow positive for the year, with GAAP profitability by the fourth quarter of2003.

This concludes the financial highlights. I'll turn the call back to Chuck for concluding remarks and Q&A.

Thanks, John.

Let's just open it up for questions.

Thank you. The question-and-answer session today will be conducted electronically. If you would like to ask a question, please do so by pressing the star key followed by the digit one on your touch-tone telephone. If you're using a speaker phone, make sure your mute function is turned off to allow your signal to reach our equipment. We will proceed in the order that you signal us and we'll take as many questions as time permits. Once again, that's star one to ask a question. We'll pause for just a moment.

Our first question today will come from Ryan Rathman with Morgan Stanley.

Hey, guys. As we - you know, as you exit Q4 can you comment on your feelings of whether or not you saw any kind of budget flush or any kind of non-normal activity toward your end? And then secondly, as you look out to '03, and coming out the quarter where about, you know, 20% of your license revenue came from new customers, what you feel like your plans are, your anticipations are for new customer growth and the percentage of revenue from new customers going out through '03?

Sure. On the Q4, economic climate was still very tough. We did not see any sort of budget flush. The notion that people have unused budget that they needed to spend by year end, I think CFOs have squashed that concept almost entirely. So the quarter looked a lot like the two or three quarters before it with respect to sales cycles. The cycles are long. All POs are getting incredible scrutiny from CFOs.

As we noted, we saw the very large companies - you know, the great bulk of our business comes out of the Fortune 500 and as you -- any look at the stock market would tell you, they're under a lot of pressure. With respect to new customers, that number bumps around because our deals -- we tend to have large deals. We have over 900 customers now. A lot of people overlook that fact. And when you have over half of the Fortune 100 and you have 900 customers, we think it's a great asset that we turned to our installed base as a source of revenue, not only repeat maintenance revenue but also buying additional applications. We cross sell and up sell a lot within the install base. So although the quarterly number can get skewed by large deals with new customers, we're very comfortable working around the 70 to 80% number with respect to cross selling and up selling in our 900 customer base.

Thanks. And then just one housekeeping question. How many quota carrying reps do you guys have right now?

Thirty one quota-carrying reps.

Thanks a lot.

Our next question today comes from Cameron Steele with RBC Capital Markets.

Thanks very much. Just of a couple of quickies here. What were -- John, what were average selling prices in the quarter? And I don't believe you gave a percentage of international contribution. It sounds like there was quite a bit of international business in the quarter.

Yes, 27% internationally. Again, most of that from Europe. There was a little bit from Asia. Our ASPs on the quarter dropped down from the prior quarter, we're still about 700,000 for the full year. This quarter, we had a lot of new deals with new customers, where they're sort of - I don't know -- I call them toe in the water deals or something, that we expect to blossom into very large deals in the future. But -- so as a result our ASPs for the quarter dropped.

Just on that point, are you seeing contracts get broken up, or are people purposefully doing smaller departmental type of things as a lead in to larger engagements.

Yes. You know, what we're seeing is, to qualify for a deal with a large company, you have to have a very broad product sweep. But they're buying a SILO solution (ph) to an incredible pain point. So to get in an RFP where, for example, an Accenture, or an IBM, or a BearingPoint is working with us, there's a checklist item that says the vendor has to have a full suite of CRM products, which we do, but then what they will be looking for might be a knowledge management solution in the short-term, or an e-mail solution in the short-term. And we saw a lot of deals of that nature where we think it will turn into a bigger deal and the company intends to spend more money, but due to the current climate, their spending was reduced and so they just cured the most obvious pain point and bought one application.

Chuck, I think earlier you mentioned that service was the critical driver of business. Within that service category, what is Knowledge -- how much is Knowledge comprised in that?

Knowledge continues to be number one. Knowledge is about 40 to 50% of the business each quarter. That's been pretty steady now for several quarters and that number gets skewed by large, really large context centered deals like the MMO2 deal, or the high mark (ph) deals, stuff like that. But pretty predictably now, if you smooth out the outlying deals, Knowledge is the number one seller.

And then the combination of Knowledge and Response is popular, too, but usually driven by the Knowledge.

Okay. And then last question, you guys have, I think, embarked on this integrator strategy. It has been about a year, I think, since - a little over a year since you guys implemented that. Can you just give us a sense from an execution standpoint, you know, where are you with that strategy? Are you comfortable with it? Is there a lot of work to be done? Or are you guys pretty much operating it at kind of full cylinder in terms of what you could be doing with those guys?

Well, I think it's working. There's still a lot of work that needs to be done each quarter. You know, if you look at the list of who we're working with, the organizations are very large, IBM, Accenture, BearingPoint, CFC, BusinessEdge, Deloitte Consulting -- you know, there's an incredible amount of attention we need to spend with these people to keep them trained and focused. But I mean, I think as you saw with today's announcement, you know, it's -- IBM and Siebel have been close for a long time and Siebel was forced to say pretty publicly that it's going to be 18 months before they have a competitive ECRM product. Now, that's a two-edged sword -- one, they're coming; but, two, the best optimistic view of it is there is 18 months before IBM and Siebel can combine with a competitive offering. So, obviously IBM looks at KANA and says, well, we can do this today, so we can do KANA deals today and if the Siebel thing comes around, then we will have a competitor in 18 months.

But, you know, we work pretty closely with our integrators because you can't find other ECRM suites. There is other players saying they're coming in, they're going to do what KANA can do, they'll soon be able to do what KANA can do, they're selling their first applications, but - you know, the integrators are working closely with us and it's going well but it's going to still be a lot of work. I mean, we don't book services, and they understand on their bottom line how important it is to have partners that don't compete with them and steal the business at the end of the quarter, and we don't. And the others who do, I think, are going to suffer.

Great. Thanks a lot.

We'll now move to Patrick Mason with Pacific Growth Equities.

Hey, guys. Just got a few questions here. One, you mentioned, you know, your quotas increased. I guess what were they and where are they now?

Well, quotas increased significantly -- they were at a little over $3 million, I think, on average per up (ph) and now they're moving to $5 million. And, you know, I think one way to view that, that really puts KANA sort of uniquely positioned is that we only quota on license revenue. So license and initial maintenance is the only thing our reps get credit for. You go to other companies who try to compete with us and they quota on services, but with smaller quotas. So I think the productivity gains we can get out of that will begin to show as we head towards trying to become the first profitable ECRM company.

Okay. That's fine. As far as the -- I guess -- you gave your guidance for Q1 on the revenue roughly in line, I guess, with Q4. It seemed like it was - I mean, it sounded like it was just -- there was no change in Q4 as far as the fundamentals, it seems like it was still kind of tough out there. Why wouldn't that be seasonally down? Are you starting off January stronger than -- fairly strong? Is that what gives you some level of conviction?

John, I will let you grab that.

Thanks.

Yes, we have a good bit of visibility for Q1. We feel comfortable that we can duplicate what we did in Q4.

Okay. Well, that's good to hear. What about your linearity in Q4, could you just talk a little bit about that -- was it any different from the dynamics?

Pretty typical. We did about half of it in the third month.

Okay. All right. Thanks a lot.

Sure.

I would like to remind everyone that if would you like to ask a question today please press star one on your telephone.

Our next question comes from Richard Peterson with WR Hambrecht.

Hi. Couple of questions. One, can you give us a little bit more of a breakdown into the composition of that deferred revenue line? I mean, just directionally is it all maintenance? Is there some license in there? What is in there?

It's virtually all maintenance.

Okay. And then, could you talk, just expand a little bit more on your comments on the competition, you know, who you saw mostly, any changes there?

Well, there's two levels. At the marketing level, we see mostly Siebel and PeopleSoft, because obviously they spend the most marketing money, but neither has the J2EE product, neither can match KANA's scalability, neither has a Knowledge Management product. So when you hit the road with respect to who the reps have to deal with, they're dealing primarily in Silos. So in contact center space, we see Chordiant more often in Europe than anywhere else.

In the U.S., E.piphany has joined the fray. They say now that they have sold their first couple J2EE contact centers. They expect to have their first installs in the summer. You know, KANA has over a hundred J2EE contact centers installed. So the way things shake out now, Chordiant is in there, they may have half a dozen installed, E.piphany says they will have one by the summer.

So I think the space will continue pretty much the same. In about a year and a half, or two years, Siebel will be in there with either a J2EE or EJB (ph) wrapper product, but somehow trying to compete on the ECRM level. So if you go deeper down into the Silos, in Knowledge Management, we don't see any of those players. We see people like Primus. Primus has some strong niches. We run into them.

On the e-mail side, Conner remains pretty much the gold standard for enterprise e-mail management. You see Departmental Solutions out there competitively. On marketing, you know, we're only doing about 10 percent of total business, but I guess Chordiant and E.piphany and Siebel would be the people we'd see in the marketing side.

And as we said, to get into a big deal you have to be able to represent that you have a full suite. But most of the deals are coming down to focusing on one application for the first piece. So you do end up sometimes in deals with players who you don't expect.

And then the - okay, thanks. And then the -- a little detail question here. Was the $500,000 in the facilities reduction, the cost that you mentioned as an ongoing savings, was that reflected in your Q4 results, or is that going to be something that starts in 2003?

It was partially reflected in Q4. There was the - I think it began in November, I believe, is when the reduction in the future payments started. But if you think about it, these were excess facilities and so there wasn't a current ongoing expense associated with that. It was just, you know, part of paying down our restructuring reserve.

Oh, okay. I thought you made a comment about an ongoing $500,000 savings-

Yes, in terms of cash outlays. So for example had we not restructured this agreement, our cash outlay would have been $500,000 greater in Q1 than it will be.

I see. Okay. I misunderstood you. Got you. Thanks.

It appears there are no further questions at this time, gentlemen. I would like to turn the conference back over to Mr. Bay.

Thanks.

Well, in wrapping, I think, you know, the highlights speak for themselves for the quarter. You know, KANA is very, very intently focused on being cash flow positive and in showing a very clear path to GAAP profitability. We think that matters a great deal to investors and we think that we have a plan that gets us there. John has mentioned that he has set the goal that at least by Q4 we have to be GAAP profitable and we would like to be generating cash right now as we speak. So I think that when you combine the management team with the 900 existing customers and the product lead that we have, we've got a nice package here. And I congratulate all of our guys out in the field for delivering a nice quarter. And that's it.

Thank you, operator.

Thank you. That does conclude today's conference call. We thank you for your participation.