SWK Holdings Corp (SWKH) 2003 Q1 法說會逐字稿

Good afternoon and welcome to the KANA Software first quarter earnings conference call. At this time, all parties have been placed on a listen-only mode and the floor will be opened for questions and comments following the presentation. I would like to now turn the floor over to your host, the Chief Executive Officer, Mr. Chuck Bay. Sir, you may begin.

Thanks. Hi. This is Chuck Bay. I'm joined by John Huyett, our CFO.

I hope you've all had an opportunity to review a copy of the press release we sent out today. Before we start our discussion of the Q1 results, John has a statement he'd like to review with you.

Thanks, Chuck, and good afternoon, everyone. 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 the effect of economic trends and uncertainties, competition, reductions in prices, market acceptance of our products, retention of employees, inability to enhance or develop our products and services within budget and on schedule, slow economic conditions, particularly as they affect spending by our prospective customers on eCRM and similar enterprise software products 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 for this call speak only as of today and no one should assume later in the quarter that comments we provide today are still valid.

Chuck?

Thanks, John. Although KANA had a solid first quarter, I don't think I need to explain to any of you how challenging the global economy has become to operate in. I think more than anything this highlights the fact that Tom Doyle, our President, and Tom Pesut, our Executive Vice President of Worldwide Sales, have done a super job of building and managing our elite sales force. These sales teams exceeded all expectations in producing another quarterly sequential increase in license revenue for KANA and I want to congratulate everyone working in and with our sales teams for another great quarterly performance.

John will be discussing the financial metrics in deep detail, but I can highlight a few significant items. Our gross margins came in again very strong at over 80%. We also significantly improved our profitability profile and, as we've said before, we're 100% committed to achieving GAAP profitability before the end of 2003.

I think this commitment is reflected in the fact that we've produced another quarter of sequential improvement in operating results. This quarter, we booked three license deals over one million dollars. This is especially impressive in an environment where CRM companies are not getting million dollar licenses and are more and more having to rely heavily upon professional services to get large deals booked. And obviously, this seems why KANA's gross margins again are the best in the CRM space.

Also, John's financial teams did a good job in Q1 and our DSOs and cash balance results are fantastic.

We continued to strengthen KANA's relationship with our integrator partners in Q1 and we currently have active customer implementations with IBM, BearingPoint, Accenture, with BusinessEdge and with EDS. Our integrator partners are continuing to train people on KANA's eCRM suite and our sales pipeline looks very good with each of the partners for Q2 and Q3.

In fact, in Q1, KANA received the IBM Beacon Award as the number one software company partner in all of North America. This is a great testament to the work of our sales and alliance teams and to the successful results IBM and KANA are bringing to our joint customer implementations.

On the competitive front, we haven't seen any material changes. We see a lot of pricing pressure on deals, but that seems to be driven as much by the economic circumstances as it does from competition from our competitors. We see a lot of companies offering free product in order to get professional service contracts from customers, but this has been true for many quarters now.

We have noticed that our integrator partners are doing significantly fewer deals with our competitors and we believe that this will produce long-term benefits for KANA. It seems intuitive that as our customers scramble to book more-- as our competitors scramble to book more professional services, it drives integrators closer and closer to KANA. We focus significant energy into maintaining and strengthening our partnerships and our joint successes with integrators.

In Q1 we added another Fortune 100 customer to our customer list and we now have 53 of the 100 largest companies in the world as KANA customers. We put a great premium on these deals because in almost 100% of these cases, these deals lead to repeat business.

In today's environment, most customers are buying solutions to specific pain points instead of overhauling complete enterprise suites of CRM applications. At KANA, this usually results in repeat business after the initial product success. We think this is a direct result of the significant and demonstrable return on investments that our applications can produce after successful integrator implementations. These demonstrable results also help KANA and our partners in our sales cycles.

In Q1 we saw activity in each of the vertical markets that we have products designed for, including Teleco, health care, financial services, high tech and government.

I think at this point we can get into a deeper analysis of the financial results and I'll pass this to John.

Thanks, Chuck. First we'll review the income statement and then the balance sheet, followed by Q2 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 22,958,000.

On a GAAP basis, our net loss was $3.9m or 17 cents per share. This is 5 cents better than consensus estimates. It also compares to a net loss of $6.8m or 32 cents per share in the year ago period.

In order to fully assess the company's financial operating results, we believe EBITDA is an appropriate measure for evaluating the operating performance of the company because it reflects the resources available for strategic opportunities, including, among others, to invest in the business, make strategic acquisitions and strengthen the balance sheet. However, EBITDA should be considered in addition to and not as a substitute or superior to operating income, cash flows or other measures of financial performance prepared in accordance with GAAP.

EBITDA for Q1 was $1,082,000 or 5 cents per share. This is 2 cents better than consensus estimates and 4 cents better than Q4 results.

We can also examine our earnings performance relative to First Call analysts' consensus, which excludes non-cash items like amortization of intangibles and stock-based compensation. In the old days, we used to call this ``pro forma earnings.''

On a pro forma basis, that is, if you calculate EPS by excluding amortization, which totaled $2.6m, our pro forma EPS is a loss of 6 cents per share, 2 cents better than the First Call consensus and 3 cents better than Q4 results.

Now some details. Revenue totaled $18.1m on the quarter, down slightly from $18.7m in the fourth quarter. As Chuck mentioned, license revenue increased sequentially to $9.4m compared to $9.3m in the fourth quarter. Maintenance revenue also increased slightly. Professional services revenue declined from $1.6m in Q4 to $943,000 in Q1, accounting for the decrease in total revenue from Q4 to Q1. Our average transaction price was approximately $530,000.

Software license revenue accounted for 52% of total revenue and combined software license and maintenance accounted for 95% of total revenue, leading to the very high gross margins, which I'll describe later. Our maintenance renewal rate continues to hover around 90%, which is a great affirmation of the value of our software.

With hundreds of 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 eBay, Sprint PCS, mmO2, Kaiser Permanente, Washington Mutual, Citizens Bank and Brown and Company, the online brokerage subsidiary of J.P. Morgan Chase.

We had 10 new customers including, significantly, Walmart.com, Yahoo Japan, Samsung and the RoadRunner division of Time Warner.

In the first quarter, 68% of our revenue was from North America, with 32% coming from Europe and Asia. Our strongest verticals continue to be communications, health care and financial services.

Once again, 100% of new deals were partner-influenced. Our partners appreciate the fact that we work with them and do not compete with them. It 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 ensure rapid, successful deployments.

Our gross margin in the first quarter was 82% of total revenue, up slightly from last quarter's gross margin of 81%.

Once again we were able to reduce ongoing operating expenses. We reduced operating expenses by 7% compared to the fourth quarter. Sales and marketing expenses were 41% of revenue this quarter compared to 43% of revenue in the fourth quarter. R&D was 34% of revenue, the same as in the prior quarter and we're continuing to reduce G&A expenses, which amounted to 15% of revenue, compared to 16% of revenue in Q4.

Moving over to the balance sheet, cash and cash equivalents, excluding restricted cash, at the end of March was $31.7m, giving us a solid level of liquidity for the foreseeable future. During the quarter we used approximately $235,000 on capital expenditures and, excluding $691,000 for leases on excess facilities, we used only $135,000 in operations. We reduced total liabilities by $5.9m during the quarter.

Working capital, excluding deferred revenue, was more than $19m. DSOs were 34 days, which I believe is an all-time record low for the company and down substantially from 96 days at June 30, 61 days at September 30 and 49 days at December 31, 2002.

Deferred revenue was $23.2m, about 1.3 times quarterly revenue. Our full-time headcount today is around 315 and our revenue per employee increased for the third consecutive quarter.

This takes me to our guidance, which is based on current information as of today. The ability to project future results is inherently uncertain and becomes increasingly difficult the longer the projection. In addition, all financial performance projections depend on success in achieving revenue targets.

Looking ahead to the second quarter and the remainder of 2003, we don't believe it's prudent for us to foresee the market improving unless current market conditions change. We believe that Q2 revenues and expenses will be roughly in line with Q1 results, but, of course, we will make every effort to move one step closer to GAAP profitability.

For the remainder of 2003 our revenues are still targeted at between $75m and $85m. Our depreciation is budgeted at approximately $2.5m per quarter. Amortization of intangibles and deferred stock compensation is estimated as follows: approximately $2m in Q2; $1.6m in Q3; and approximately $1.5m in Q4. EBITDA is expected to be between $7m to $9m for the year.

Based on these assumptions, we expect to be cash flow positive for the year, with GAAP profitability by the fourth quarter of 2003.

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

Thanks, John. As you can see, there were a lot of positive things happening at KANA in Q1. I would reiterate that although we don't see any signsificant of economic recovery and we are certainly not counting on any in the near future, we will continue to strive to improve our profitability profile every quarter as we move forward.

Let's open for questions right now.

Thank you. The floor is now open for questions or comments. If you do have a question, please press the number one followed by four on your Touch-Tone phone at this time. Please hold while we poll for questions.

Our first question comes from Cameron Steele of RBC Capital Markets.

Thanks very much and congratulations on the quarter. Chuck, could you comment on your professional services business who had dropped quarter-to-quarter? Maybe just give us some guidance on what your intentions are there with your people. Are you going to continue to-- are you not going to invest in it further or is it going to be-- is this more of a one-time blip?

Well, the truth is, we're not exactly sure. You know, part of our core strategy is to steer every dollar of professional services that's possible to our integrator partners. However, sometimes you get deals booked with customers who have infrastructure that is so complex they have to get some specialists from KANA to help with installs.

In the past quarter-- You know, the products are really good products that do what we say they do and when you have that mix you can use integrators for the services. So we take it as a great sign that the products are performing, they're doing what we say they do without having to have a lot of KANA humans writing custom code, but, you know, it can bounce around. If we book a big, complex deal with a lot of messy infrastructure in Q2 you could see some significant bounce in services, but I see no reason why it would bounce above a million dollars unless something unusual happens.

So I think we don't really guide to that line, but under a million we take as an A-plus on our part because it means the integrators are getting all the services that they can eat and the products are working out of the box.

So did you let people go in the quarter in that group? Or--

No. No, we redeploy. When they're not actively billing per hour, they're helping to train the integrator partners, they're helping to train new SEs, they're working with the R&D groups to give product feedback and so they're all here.

OK. And just another quick follow up. On the large deals, what kinds of projects are people-- are they doing? Is it all online service? Or just give a flavor of what people are spending money on with you guys right now.

Well, it's not all the same kind of online service, but that is our core competency here is using the Internet to leverage customer service. I think we did a great job of moving forward the contact centers this quarter. About half the deals were contact center deals and then a very significant amount were the KANA IQ knowledge management product. That's always a strong performer, but this is the first quarter in a while that IQ hasn't led the way.

We take that as a good sign. You know, long term we see great value in our contact center that can help people run call centers but also be pointed out through their portal to allow self service over the web, save a lot of money that way and we're hoping to see that trend continue.

And just finally, can you talk about what's-- what you're doing at eBay? Thanks.

Sure. Well, we do a lot of things at eBay. eBay is a very intense user of KANA Response and KANA Connect. They have unprecedented value to us because they push the limits every quarter. They increase their volume and their activity with the products and they're always very anxious to feed that back into our mainstream product path and I think that eBay is one of the customers where we made some progress. They tried some competitive products that didn't work and they're going to try a Contact Center from KANA now. They took some licenses in Q1.

Great. Thanks very much.

Thank you. Our next question comes from Patrick Mason from Pacific Growth Equities.

Yeah. Just a follow up on eBay. I guess Epiphany said they won a deal there. Is that one of the competitors that you're replacing, I guess or just being complementary to?

I don't know. We don't really track what Epiphany does.

I guess you-- but you'd be familiar if they were in there, right? They obviously signed up something. I'm just trying to get a little more color on it.

They might have been one of the ones that were in there trying to do something but it didn't work out.

Secondarily, just on the million dollar deals you obviously did three this quarter. That's great. I guess as far as from a pipeline standpoint in Q2, you know, obviously, you gave some guidance, you know, a little bit of guidance there. Do you need to do another three deals or do you have enough other deals in the pipeline to help make up for that if you only had like one million dollar deal? A little flavor on that, maybe.

We have enough pipeline to cover it any way you cut it.

Yeah.

But I can't over-emphasize to you how hard it is to sell software these days. CFOs around the world are stopping Cap Ex expenditures and so you can get IT sign-off, CIO sign-off and business user sign-off and then the CFO will sit on it because they want to see how their company's quarter comes in before they spend any cap ex. We run into that an awful lot. So we have enough small deals to cover everything. We have enough large deals to cover everything. Harvesting those deals in today's environment is a challenge and, you know, we all watch the news every night. It's getting harder every day. It has not gotten easier in two years.

And I guess just another follow up a little bit on that. I mean, do you guys see anything attributed to the war or do you specifically cite that as one of, maybe a deal or two that maybe rolled into Q2?

No. No, I don't think--

--as opposed to [inaudible]

I don't think the war is impacting the customer service effort. You know, companies around the world are trying to improve customer service and reduce the cost of customer service and that's what we do. The war doesn't have that much, but the economic drag that's going on around the globe right now is certainly hurting and, you know, everybody asks us, is SARS hurting us?

You know, planes are empty but it's the CFOs who are so nervous in the Fortune 500 that is really is what's hurting business more than anything. It's the mentality of, ``I'm not going to spend any money until I see how my quarter comes in,'' which trickles down. You know, that's the way we run this company now. We don't spend money until we see how the quarter goes.

Right.

Pat, this is John. Let me just add, also, that, you know, while we like the big deals and we're focused on them, we had-- in Q4 we didn't have any deals over a million and in Q3 last year we only had one.

Right.

So we're not dependent on them. We like them, but we're not dependent on them.

Well, that's what I was expecting. I just wanted to hear you guys talk a little bit about it. And lastly, have you guys-- did anything roll into April and then close early on from a linearity standpoint starting out this next quarter?

Yeah, we have-- we have a major bank on the East Coast that we closed.

All right.

Just recently.

Good deal. Well, all right. Well, great quarter, definitely. Thanks.

OK. Thanks.

As a reminder, the floor is open for questions or comments. If you do have a question, please press one followed by four on your Touch-Tone phone at this time. Our next question comes from Richard Petersen from W.R. Hambrecht.

Hi. I wonder if you could just give us a little more detail on competition and barriers to getting deals closed this quarter? If it's changed at all, I'd be particularly interested in hearing how it's changed. Thanks.

No. You know, the competitive situation really breaks down by product line. You don't see a lot of companies overhauling their whole CRM suite. You do see some contact centers getting replaced and when it's that front you always see Siebel and PeopleSoft, always. If it's IQ we tend to see some of the lower end -- lower end meaning lower end price point -- companies like ServiceWare or Answer Friend. You know, everybody's looking at those things now, seeing whether search is powerful enough to compete against knowledge management, but we usually win those deals.

On KANA Response, there still really does not exist a competitor that we've found. So if it's a KANA Response deal we tend to either win it or it gets deferred.

But PeopleSoft and Siebel, as they get more and more aggressive and, you know, in tough time everybody gets more aggressive, we see them more and more. You know, the marketing app is maybe 5% or 6% of our revenue, so in those situations sometimes we see Cordin [ph], sometimes Siebel, sometimes PeopleSoft. We don't really do data marts any more, so we don't run into Epiphany.

Who else do we see? That's about it. I mean, it's really not changing much. There used to be 20 little tiny companies out there, but most of them have been gobbled up or are refocusing right now and we don't see that much of them and we try to check hard on who we're seeing in the deals to make sure that our marketing people have kept up.

You know, closing deals is the hard part. Beating competitors is what we're good at in all economies. Getting a CFO to sign a PO, that's the challenge.

Right. OK, great. Thank you.

Gentlemen, we're showing no further questions at this time.

OK. Well, then, I think in closing I'd just like to remind people that we are as focused as anyone can be on holding the margins up, getting the profitability and preserving cash and hanging in through these tough times. We're doing a great job so far and we believe that if we stay focused on it we can keep doing it. Thanks.

Thank you.

Thank you. This does conclude today's teleconference. Please disconnect your lines at this time. Have a great day.