SWK Holdings Corp (SWKH) 2003 Q4 法說會逐字稿

Good afternoon, and welcome to the KANA Software fourth-quarter and fiscal 2003 year-end conference call, with your host, Chuck Bay, Chief Executive Officer, and John Hewitt, CFO. (OPERATOR INSTRUCTIONS). It is now my pleasure to turn the floor over to your host, Mr. Chuck Bay. Sir, you may begin.

Thanks. Hi, this is Chuck. I am here with John Hewitt, our CFO, and John has a statement he would like to make before we begin.

On this call, we will be making forward-looking statements regarding anticipated events and the future performance of the company, including statements regarding our expected revenues, expenses, profitability, cash flows, margins, operating results, our long-term success, our products and product development efforts, our pending acquisition of Hipbone, 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 competition, market acceptance of our products or services, our product development efforts, employee retention, cash management and our efforts to grow our sales, pending Hipbone acquisition, our ongoing arrangement to outsource development activities, the effect of uncertain economic conditions on spending by our prospective customers, and other factors described in our most recent filings with the SEC, including recent reports on Form 10-Q and Form 10-K. In addition, I want to emphasize these forward-looking statements are based on judgments, and that individual judgments may vary. The forward-looking statements for this call speak only as of today, and no one should assume later in the quarter that the comments we provide today are still valid. Chuck?

Okay, let's start. I hope you have all had an opportunity to review our Q4 earnings press release. As you can see, we reported a strong quarter. We owe a significant thanks to Tom Doyle and his elite sales teams. Q4 was strong for both license sales and for maintenance renewals at KANA. Our gross margins were strong, and again, are the best in the CRM space.

John is going to review details with respect to Q4 financials in a moment. And I would like to mention just a few of the highlights and accomplishments in the KANA operations. First, our R&D groups have completed an amazing transformation. Five quarters ago, we embarked upon a goal to increase the pace of new product development by magnitudes. We had a very significantly lead in the CRM space with respect to our knowledge-enabled CRM applications, and we needed to ensure that no one would be gaining ground on us.

We chose to partner with IBM (indiscernible), Century India, HCL Technologies in India, and BearingPoint in China to increase development capability and increase the pace of new product releases. Today, the transformation is pretty much complete, and our development and release capabilities are greatly enhanced.

In the past year, we released the KANA contact center suite on not only the J2EE EJB platform, but also the .net platform. In addition to that, we developed and released the first verticalized versions of our applications suite. These verticalized applications were designed and developed jointly with integration partners of ours, and we are already taking these applications to market jointly with our integrator partners. This is true in both the Telco and the financial services sectors.

I should also mention that again in Q4, 100 percent of our deals were done in conjunction with our integration partners. KANA's strategy of never bidding against integrator partners for implementation dollars clearly distinguishes us in the CRM space, and we continue to believe in the success of that model.

Although we did well in Q4, I certainly cannot say that we are now seeing an economic turnaround in the enterprise applications space. We continue to see very cautious ROI-based purchasing groups within the global 1000, and we continue to see CFOs within the global 1000 blocking or delaying large enterprise application purchases. However, on the other side, our pipeline of deals is growing, and our field sales teams are seeing an increase in the number of deals initiated by our integration partners. Both of these signs are very positive.

In Q4, we announced the acquisition of a (indiscernible) company named Hipbone. This company has excellent chat, co-browse, and file-sharing applications, and this further enhances our product lead in the CRM market. Let's turn to John for discussion of KANA's Q4 financial performance, and then we will have some broader discussion and open forum.

Thanks, Chuck. We are very pleased to have beaten analysts expectations for the quarter, and to have moved closer to our goal of sustainable GAAP profitability. Revenues for the quarter were $17 million, above the main consensus revenue estimates, and 23 percent higher than third-quarter revenue.

License revenue was $8.6 million, an increase of 69 percent over the 5.1 million in license revenue reported in Q3. Fully diluted weighted average shares outstanding for the quarter were 26,405,000. The weighted average number of shares outstanding includes the partial quarter impact of our stock offering, but does not reflect the 250,000 shares expected to be issued in the Hipbone acquisition.

On a GAAP basis, net loss narrowed to $3.4 million, or 13 cents per share. GAAP net loss includes 1.4 million in amortization of stock-based compensation, 1.7 million of restructuring costs related to access facilities, and a $500,000 write-off of an investment that was made in a privately held company several years ago.

Operating loss, which includes $3,129,000 of amortization and restructuring charges, was 2,751,000. This marks the first time in nearly two years that gross profit has exceeded the sum of sales and marketing, research and development, and G&A expenses.

License revenue accounted for 51 percent of total revenue in the fourth quarter, compared to 43 percent of total revenue for the year. North America was particularly strong in Q4, accounting for 86 percent of revenue in the quarter, compared to 73 percent for the year. The company booked three deals in excess of $1 million, all in North America. We gained seven new customers, including SBC Communications.

Most of the new orders, including all of the seven-figure deals, were for our service resolution products, based on KANA IQ. Our strongest verticals continue to be communications and financial services, followed by health care, retail and technology.

Combined, software license and software maintenance comprise 93 percent of our total revenue. I am very proud that our maintenance renewal rate continues to hover around 90 percent. In my view, this is a real testament to the value of our software, and our commitment to absolute customer satisfaction.

Maintenance revenues were 7.3 million in the fourth quarter. Concurrent with an agreement to enhance and extend an important strategic relationship, we issued a 5-dollar warrant for 230,000 shares to a strategic partner who is also a customer. In accordance with Emerging Issues Task Force issue 0109, the Black-Shoals value of the warrant, approximately $460,000, was treated as a onetime reduction of revenue in the fourth quarter.

Gross profit in the quarter was $13.6 million, or 80 percent of revenue, which once again, we believe, is the highest in the CRM space.

Sales, marketing, research and development, and general and administrative expenses totaled 13.3 million in the fourth quarter -- a 24 percent reduction, compared to 17.4 million in the fourth quarter of 2002. This reduction was weighted across the board in all of our operating line items, and is the successful result of our internal cost controls and offshore efficiencies.

For the quarter, sales and marketing expense was 41 percent of total revenue; research and development expense was 28 percent of revenue; and general and administrative expense was 9 percent of revenue. Sales and marketing expenses were $7 million -- up about 160,000 from the prior quarter, reflecting the increase in commissions expense associated with the increase in revenues.

R&D was relatively flat at 4.7 million. G&A was reduced from 2 million in the third quarter to 1.6 million in the fourth quarter. Lower legal expenses and reductions in bad debt expense contributed to the decrease in G&A.

Amortization of intangibles and stock-based compensation for the quarter was 1.4 million, and restructuring costs were 1.7 million. The restructuring costs related to changes in estimates related to excess leased facilities, particularly in the United Kingdom.

Our full-time headcount today is 211, down from about 365 at the beginning of the year. We ended the quarter with 21 quota-carrying sales reps.

Annualized revenue per employee in the fourth quarter exceeded $300,000 for the first time in KANA's history.

Now, moving over to the balance sheet. Cash and short-term investments at the ended December was $33 million. Cash increased by 10.7 million during the quarter, and was influenced by several operating and non-operating items, including the $13.1 million financing completed in Q4, and property and equipment purchases of a little over 300,000.

Cash used in operations was approximately 2.6 million. Prepaid insurance and royalties accounted for half of the net cash used in operations. And approximately $1 million was used to reduce accounts payable.

Working capital, excluding deferred revenue, increased to $24.7 million. Accounts receivables increased by $1.7 million, reflecting our higher revenue. DSOs at December 31st were only 42 days -- up slightly from the 40 days in the prior quarter, but better than our target of 45 days, and still among the best in the industry.

Our quick ratio, defined as free cash investments and net receivables divided by current liabilities other than deferred revenues, was 2.1 to 1. Deferred revenue at December 31st was $21.8 million -- a slight increase over the prior quarter, and equates to 1.28 times quarterly revenue.

As far as guidance -- guidance 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. So again, we will be providing very limited guidance. We expect sales and marketing, R&D and G&A expenses to increase my 5 to 6 percent over the recently-completed quarter. The increase is expected due to increased personnel costs, and increased engineering and marketing efforts related to our new vertical products. We expect amortization of deferred stock compensation to decrease by approximately $900,000 in Q1.

CapEx is budgeted at less than $500,000 per quarter for 2004. We expect the weighted average number of shares outstanding in Q1 to be approximately 28,700,000 shares. That is 28-7. This includes the full effect of the 4,692,000 shares issued in November, and the anticipated issuance of 250,000 shares in the Hipbone acquisition.

The Hipbone acquisition will be accounted for under the purchase method of accounting. The total value will be measured at the closing date, which currently is expected to be in early February. Merger expenses related to the acquisition are expected to be less than $500,000, and will be included in the Q1 operating results.

As Chuck mentioned, we have made important progress towards our goal of sustainable GAAP profitability. As a company, we continue to be 100 percent committed to achieving GAAP profitability.

Before I turn the call back to Chuck, I want to remind everyone that we will be presenting at the Roth Capital Partners Growth Conference in Southern California on February 17th. And this concludes the financial highlights. I will turn it back to Chuck.

Okay, let's open it for broader discussion and take some questions.

(OPERATOR INSTRUCTIONS). Cameron Steele, RBC Capital Markets.

Thanks very much. Chuck, you mentioned your system integration partners are starting to really help you guys, I think in terms of pipeline and leads and recommendations. Can you talk about who -- you mentioned you had three big deals this quarter. Who is instrumental in getting you involved there? And who is going to be working with these customers, going forward? And then, can you just talk about -- you mentioned the pipeline is improving. Can you talk about who is contributing to that and where you are seeing leverage? Which partners are showing leverage to you? Thanks.

Sure. In Q4, IBM and BearingPoint were on the big deals. Both have contributed to our pipeline of deals, and so has Accenture lately. But, I think from our three large deals in Q4, they are split between IBM and BearingPoint. We are seeing all the integrators -- IBM, Accenture, BearingPoint, Business Edge. They are honing in on our value proposition of taking the KANA suite of applications, based on our knowledge-powered CRM approach, and taking it to the market. They had been really key in jointly developing the verticalized versions of our apps. And so, what we saw is from last summer until roughly October, we were in the design-and-build stages. We got the releases out in December, and now they are beginning to focus on taking those verticalized products to market. So, they have long sales pipelines, we're looking at Q4, maybe Q3, to start getting a tailwind from our integrator selling efforts. But, they are currently jointly selling with us. By that time -- by September or December, we should be seeing deals they have generated.

And Chuck, can you talk a little bit about the vertical apps? Are these being targeted at Telcos in the financial services vertical at specific business processes? And, I guess, how you guys plan on taking these to market? And what processes are you really targeting?

It is in the communications vertical and in the banking -- specifically in banking sectors within financial services. What we did is -- last summer we sat down with our largest partners and said "where do you feel companies could most use the benefit of enterprise applications in customer service?" And, it came out with pretty precisely from all three of the large integrators, issue resolution is the next big thing to tackle with an organization. So, calls can be routed. That was late '90s technology. Customers can be tracked. Customers can be ranked. That was late '90s technology. And now, companies are moving to "how do I answer my customers' questions efficiently and effectively?" So, you need to reduce training costs; you need to reduce turnover; you need to be able to make knowledge available to people answering phones, whether they have worked there two weeks or two years. The consistency of answers helps customer service a lot. So, all three of the big integrators came in and said that's where they would like to move with us, and so that's where we are seeing the action now. They bring us into their customers; it is consistently on a "let's go find out where the customers are asking their questions. Is it on the Web? Is it in a call center?" And find the best way to leverage the KANA applications, specifically the knowledge-powered CRM approach.

So, I think we are looking at a pretty good year. It might still only be like a 20 percent growth year for KANA on the top line. But, you know, we are seeing increased activity.

Okay. Great. And then, final question -- you had a real heavy contribution out of the KANA IQ product in the quarter. Should we expect a little more diversification in your contact center offering and other product areas over the course of the next couple of quarters? Is this kind of a unique quarter? Or is IQ really dominating the pipeline in interest right now?

Yeah, IQ is very strong. But, when we talk about our verticalized applications, it is a combination of IQ and the contact center and the e-mail application. So, we will dominate discussion around the knowledge-powered suite, but, in most cases, it will be more than one application, we think. So, the theme will be knowledge-powered, and IQ is the knowledge. So, we would expect IQ to be in almost all of our deals. Some will have e-mail, some will have contact, some will have outbound connect e-mail management. But, the consistent theme for this year seems to be knowledge-powered CRM with us.

Great. Thanks very much.

Patrick Mason, Pacific Growth Equities.

Yeah, just a couple of questions. I guess the first one is -- what is up with the warrant? What was the reasoning behind that?

Our largest integrated partner came to us and said "we have a global program for alliances at the highest level. We want you to issue us warrants, and jointly we will create success in the market. And when the warrants are in the money, we will slowly begin to sell them off, and we will use the proceeds for joint marketing, specifically for the alliance KANA and the integrator." We think that is a great idea. We had not seen that as a program within a large integrator in a long time. And so, no one had to hold a gun to our head to get us to do it; we thought it was a great idea. The best part being that when the warrants are exercised and the shares are sold, the proceeds go to joint marketing.

Is that contractual? Or is that just verbal?

That his contractual.

As far as -- you said you are going to have an increase in expenses from the current rate of -- is that like from 13.3 million, roughly? That is going to increased 5 to 6 percent going into Q1?

Right.

I, see this is in personnel and R&D, and I guess a couple of other areas. On the personnel side, where are you planning on increasing and by how many?

Well, we are adding less than five people from Hipbone. We are always adding sales and sales engineers. So those are the areas that we are currently adding personnel.

5 from Hipbone, and then on the -- ? So this is all Hipbone-specific? Or is this -- ?

No, we are adding a few of the engineers and a couple of folks from Hipbone. And then we are adding in the sales area. That's the only places that we are adding, currently; we're not going to get ahead of our revenue.

So, five total for all that?

No, there may be three or four sales teams with a salesperson in (indiscernible). Also, I think we're going to notch up a little bit on our investment overseas and developments. We have a lot of requests now from the integrators to expand our products and add some new verticals for them. So, we might add another quarter million, say, per quarter for that -- specifically for offshore R&D with integrators.

And that is in R&D?

Yes.

Okay. You mentioned -- I just overheard this -- 20 percent growth for KANA. Are you saying that's for FY '04? Are you talking about total revenue growth or what --?

If you look at the Q4 results and say "how will the year play out?" You know, there is always the seasonal dip in Q1, but we think at this point -- by the end of the year, you will have seen about 20 percent growth. Maybe a little more. But, the tailwind won't be hitting until the end of the year. So a lot of it is just organic growth.

All right. So, I mean, currently analysts are basically saying 10 percent, a little more than 10 percent growth. You're saying it will be more than that?

I'm hoping so. We are very conservative on guidance.

Okay, but Q1, you expect normal seasonality -- (multiple speakers)? And a little bit more expenses from your current run rate. Is that basically the case?

Yes, a small increase in expenses, and then the typical Q1 dip.

Okay. All right, let me just look at my other list here. So the pipeline is looking good, you're not signing up for the economy changing much on turnaround side, and that is about it. Okay. Thanks. That is all I need to hear. Thanks.

There appear to be no further questions at this time.

Okay, in closing, I will just say that our business model is based on success with integrators. The integrators, as you all know, are very large organizations. They are not claiming to be pulling out of any economic slump. I think we're all moving cautiously forward, but the best news is the pipeline is being built jointly. The products are being designed and built jointly with the integrators. They are investing resources in KANA's success. We are investing resources in their success. And we believe this can pay off significantly beginning in September/December quarters. Until then, it is organic growth. But, we feel pretty good about the prospects there. So, that is it, operator.

Thank you, sir. That concludes today's teleconference. You may disconnect your lines at this time, and have a wonderful evening.