SWK Holdings Corp (SWKH) 2004 Q1 法說會逐字稿

Good afternoon and welcome to the KANA Software first quarter 2004 earnings conference call. At this time, all parties have been placed on a listen-only mode, and the floor will be open for your questions following the presentation. It is now my pleasure to turn the call over to your host, Mr. Chuck Bay, Chief Executive Officer of KANA Software. Sir, the floor is yours.

Thank you. Hi, this is Chuck. I am here with John Huyett, our CFO and with Tom Doyle, our COO and President. And John has a statement he'd 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 flow, margins, offering results, our long-term success, our product and development efforts, and characteristics of our market segments. Actual events or results could differ materially from those described or anticipated in these forward-looking statements. And as a result of a number of factors, including risks associated with our efforts to grow our sales, our reliance on large orders to meet our expected sales in a given period, our sales cycle, our ability to manage our expenses, our reliance on international development partners, competition, market acceptance of our products or services, 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 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 in the future that the comments that we provide today are still valid. Chuck?

Thanks. I hope that you have all had an opportunity to review our Q1 earnings press release. In a few moments, John is going to give some analysis and color to the financials. Our results are in line with our previous release on April 1. The results were below our expectations for the quarter, however. As we discussed in the January call, the economy remains difficult and our POs (ph) are still subject to a broad timeframe for closure.

As our integrator partner-centric model has matured, we are seeing and experiencing bigger and broader deals. And while it is great to have a lot of large deals in the pipeline, we are in a transition period of getting a better handle on the closure process for integrator-led deals. When KANA generated the leads on our own, and closed the deals and then handed implementation and integration to integrators, we were very experienced at managing and forecasting the closure process. However, as we have moved through the process of having more integrator-led deals than KANA-led deals, the closure process has become less in our control. We underestimated the effect of this transition and it showed in our Q1 results.

Tom Doyle and his teams are working very closely with the integrators to improve our ability to forecast the closure rates of the deals. We've worked incredibly hard through the past years to get to the level where integrators lead our deals, and now our primary challenge is to complete the transition and become accurate and dependable in managing closure process with the partners. These partners have complex sales cycle that are longer than the traditional KANA sales cycle. However, we remain absolutely committed to the integrator partner-centric business model. The ability to scale and to become a significantly sized profitable company has historically been considerably enhanced in the integrator-partner model. As we've consistently demonstrated, we can produce gross margins in excess of 80 percent. And when we combine this with the scale that can be accomplished when integrators are helping to lead deals, we believe that it is worth fighting through this transition period.

Turning to the market for a moment, we're not seeing any significant changes from year-end. We typically are selling into the Fortune 1000, and they seem to remain very cautious with respect to large capital expenditures. Financial services sector and the telco sector seem to be the strongest sectors today. We've seen our pipeline grow significantly over the past six months, and a lot of the growth is in the financial services and telco sectors. The pipeline is reviewed on a weekly basis with each of our integrator partners and they seem to have strong focus around both these, telco and financial services sectors, as well as us.

Government, high-tech and health care seem to be the next level of interest with KANA and their integrated partners, and we've seen small growth in the pipeline for those sectors. However, the pipeline overall is growing sufficiently to fuel our success over the coming three quarters.

On our product development front, we continue to work very closely with the integrator partners, and we are jointly developing specific applications for vertical markets. IBM, Accenture and BearingPoint are all working with us to identify the appropriate sectors and to continue to produce very targeted solutions for the verticals.

I visited with the IBM, Accenture, and HTL development teams last week in India, and they are all making progress in working with us on our application suite. We now have approximately 200 developers in India and China and our outsourcing strategy is working to produce a broader suite of applications, much faster than we could otherwise have done without the outsourcing.

At this point, I will turn it over to John, who will add some color on the financials. And then Tom, John and I will be open for questions.

Thanks, Chuck. As Chuck mentioned, we're disappointed with the first-quarter results. However, we're addressing a large market with a proven solution. The level of interest shown by the integrators and growth in our pipeline confirms this.

Our quarterly license revenues are difficult to predict and may fluctuate significantly from quarter to quarter. The two-edged sword that we face is that our business model is highly leveraged and even smaller increments or shortfalls in revenue have a powerful impact on our bottom line. In building our internal forecast, we look at both pipeline and conversion rate. We have been examining our pipeline rigorously, integrator by integrator, vertical by vertical, deal by deal. Our pipeline is strong and is growing. We're working hard to improve the conversion rate and our ability to forecast when a deal will close. Our sales team is fanatical about defining probabilities and projecting deal closure rates. However, forecasting when a deal will close continues to be very tough.

(indiscernible) for the quarter ended March 31st, 2004 were $13.3 million, in line with our previous announcement. On a GAAP basis, EPS came in at a 14 cent loss per share, or $4.1 million, also in line with our previous announcement.

Fully diluted weighted average shares for the quarter ended March 31st were 28,640,000. License revenue was 4.6 million and accounted for 35 percent of total revenues. Maintenance revenues were 7.8 million, or 59 percent of revenues. And service revenue was 910,000, which represented 7 percent of revenues.

Our combined software license and software maintenance constituted 93 percent of our total revenue this quarter, resulting in an overall gross profit of 9.9 million, or 75 percent.

The benefits of the integrator model are very clear. Gross margins are much higher in this model than in the hybrid software model, and we strongly believe that the long-term value of KANA will be greater by executing our business model in this fashion.

Existing customers accounted for the majority of our license bookings. Important wins in Q1 included new customer, TD Waterhouse, and repeat customers Siemens, BellSouth, Nissan Motors, and Met Life. During the quarter, 66 percent of our revenue was from the U.S., with 34 percent coming from overseas. There were no deals over $1 million booked in the first quarter, which resulted in the average transaction size dropping to $258,000, down from $740,000 in Q4 of 2003.

Our strongest verticals continue to be financial services and communications, followed by manufacturing, technology and retail.

Sales and marketing expenses were $6.5 million, or 49 percent of total revenue. This was down 600,000 from the prior quarter, primarily reflecting reduced commissions. R&D expenses, representing 38 percent of revenue, increased 6 percent from the prior quarter to just under $5 million.

G&A expenses, representing 15 percent of revenue, increased to just under $2 million, an increase from Q4, but down 27 percent compared to Q1 of last year. We believe that our cost structure should be relatively stable going forward, with G&A, sales and marketing and R&D running essentially flat in terms of absolute dollars.

Amortization of intangibles and stock-based compensation for the quarter was $562,000. Looking ahead, we expect this to be approximately $400,000 in Q2, $300,000 in Q3, and $100,000 in Q4 of 2004.

Our full-time headcount at March 31 was 209, and we ended the quarter with 20 quota-carrying sales reps. Cash and cash equivalents at the end of March totaled $33.2 million, an increase of 200,000 over the December 31st balance. We generated a little over $400,000 in cash from operations. Accounts receivable was down by 2.3 million, reflecting our reduced revenues.

DSOs at March 31 were 38 days, an improvement over the 42 days at December 31st, 2003. This is better than our target of 45 days, and among the best in the industry.

Our quick ratio, defined as free cash investments and net receivables divided by current liabilities other than deferred revenue, is 1.9 to 1. And our working capital, excluding deferred revenue, was over $21 million. Deferred revenue of March 31 totaled 21.5 million, relatively flat from the prior quarter.

Lastly, during the first quarter, we concluded the acquisition of Hipbone in exchange for 262,500 shares of common stock. As a result of this acquisition, KANA has added Hipbone's web collaboration, chat, co-browsing and file sharing capabilities to the KANA iCARE suite. The acquisition was accounted for using purchase accounting, and total consideration, including transaction costs, was $1.4 million. (indiscernible) the acquisition closed mid-quarter, we expect our weighted average fully diluted share count to increase to approximately 28.8 million in Q2.

This concludes our financial highlights. Operator, we would like to open it up for questions now.

Thank you. The floor is now open for questions. (OPERATOR INSTRUCTIONS). Denise Rush, Roth Capital Partners?

Hi. I was wondering, Chuck and Don, if you could talk a little bit about the deal push-up that you saw in the quarter? If you can give us a sense of the size? If any were lost to competition? Or is there more related to the longer sales cycles with the integrators?

This is Chuck. It was a bit of a mix. I am going to let Tom add onto this, rather than go into the details, which he knows much better than me. We did not lose a single deal to a competitor. However, in some cases, the company pushed the project out. In some cases, the integrator won their piece, but they are not ready to give us our piece yet. In that case, certain milestones in the integrator project had been moved by the customer. So, the time when we thought our PO was coming, got moved out, and we have to wait for the integrator to catch up on some work before we are going to get the PO. And in some cases, it was budgetary constraints within the customer. So, it is a mixed bag of deals.

I can tell you that of the four or five largest deals that could've closed in Q1, all moved out; none have closed as of today. All could close in Q1 except one of them. So there's still four that are being juggled. We are working as hard as we can to get the forecasting process better understood now that we are being pulled through the cycle by the integrator rather than being relatively independent to close the deal. But, Tom is the expert. He is here.

Hi, Denise. This is Tom. To a general statement, I would echo everything Chuck said. I think he is completely accurate on the status of the deals. None of the deals were, as Chuck mentioned, were -- actually, even at the end of the quarter, were down to a competitive threat. They were all down to procurement and budgeting cycles. We feel strongly that the four deals Chuck alluded to are well in hand now. Based on our experiences, we are a little gun shy on exactly the close date, but we feel very strong about the percentage in the sales forecast system that they are going to be KANA wins.

Okay, and then as a follow-on, can you go through a little bit more of in what ways the relationships with the integrators have matured? Has it gone from, at all, a consulting backup to a cold-sale type of situation where you are developing up the vertical, developing out sales teams that work together to sell? Could you give us a little bit more information on that? As well as could you talk about the up-sell to existing customers in the quarter?

Sure. The collaboration between KANA and the SIs has been an effort we've been working on for two years. Over the last couple of quarters, we have moved to a whole new level of joint selling with our SI partners, and that led somewhat to the visibility issue which we had in Q1 in terms of the close dates.

Today, what we have is a pipeline that has generally built joint sales activities between our sales teams and the systems integration partners from the early stage of the sales cycle. So from a collaboration perspective, we're seeing now the maturing of the pipeline, a whole new kind of pipeline, which gives us the scale and expensability that we were hoping to get. And I think we've talked about that we feel good about the quantity and quality of the pipeline already on this call. And so, I think where we are is, maturing of the pipeline in this new model, of having integrator-led sales with the strong collaboration between KANA and the partner.

We have, Denise, because of the significant development projects that we had underway for a couple of -- at least for last year, where we've moved our entire product line to a common suite. It has opened up a significant cross-sell and up-sell opportunity for KANA in our installed base because of the common platform which we have been able to release our products on. So, I think you'll see a significant portion of our revenues over the next few quarters come from programs driven at targeting our very large installed base to drive cross-sell and up-sell opportunities.

Okay. And then just from an expense side, should we expect -- I know that John said that it would be flattish -- is there any plans, investment or integration that will affect R&D and sales and marketing in the next couple of quarters?

No, there's no significant changes planned. The most significant expense now that is not to employee salaries is to the India and China developers. And all those people are working on joint -- KANA-IBM, KANA-Accenture, KANA-BearingPoint initiatives. And those initiatives are really driving the relationships. What changed -- Tom alluded to the fact that it was last June that we released the contact center with the common platform for all the applications. That's what brought the integrators in, in a really serious way, because no one else has that suite. That was when we first designed the joint product offerings, where the integrators helped us define the domain expertise that we needed to build into the application to be differentiated from all the other CRM players.

And that's when these new sales pipelines really kicked off in a big way, was last August, September, October. And as we managed through that, it's turning out that the move into India and China was probably one of the best moves we could've made because it allows us to react very quickly, in a very efficient way, to develop products jointly with our integrator, which is what they prefer -- they prefer to go in to a customer saying, "we have jointly developed with KANA this very specific solution for, for example, retail banking call centers." And they feel that is a much better value proposition in today's world to help them. So, it's differentiated us, and it doesn't need to increase. As I mentioned, it's about 200 people now in India and China. But we don't plan on changing it in the near-term.

Okay. And then last question, with your Hipbone acquisition being a hosted solution and KANA being largely license-centric, how does that play into your strategy going forward?

Well, the theory we have is that if it is there -- we are constantly looking at the hosted world. We're always asked about it and we're looking at it a lot. There is a lull in mid-end market. People who would never be buying enterprise applications and using, for example, IBM to install them, or Accenture or BearingPoint, where they will entertain a hosted solution on a departmental level. And so, we have retained the ability for Hipbone to operate on a hosted basis. But we have also completely rewritten the Hipbone interfaces, so that it is now also a module on response. The enterprise-level e-mail management system now also has all the Hipbone functionality in it.

For right now, we are working both tracks. Brian Kelly has been with us since about last June, and he felt very strongly that we should leave both options open. We want to make it clear, though, that at the high-end enterprise level, we will not compete with the integrators who do love to host an outsourced at the high end, but they won't go after the low end and the mid-market. We retained that ability to work with Hipbone. We are going to see how the market reacts to it. And Brian is looking forward to that business growing significantly.

Okay. Thanks, Chuck.

Patrick Mason, Pacific Growth Equities.

Yes, I'm just curious, you talked about the four or five deals that got pushed out -- are those primarily KANA IT-product-related deals? Or could you give a little flavor on what composes those large deals? What you're selling?

Sure. I'll give you a little bit of flavor on -- some of these -- there's five deals which we talk about that we had good visibility in, in Q1. A couple of them in the U.S., a couple in Europe, and one in Asia. The product set is really now being driven -- is not just kind of KANA IQ. All the KANA products now are being driven through the knowledge-powered applications. So IQ is a key part in generally all of our sales. But the customer base, in this particular case, covered literally all the KANA product sets.

Some deals where IQ and contact centers, some were IQ and response. It is a mixed bag now.

Okay. Because it was -- for a while, it seemed like you were selling more IQs than anything else. And you're saying that that mix has changed to a more balanced product set?

I think I was referring specifically to these four --

Okay. All right.

I think IQ will still lead the way for us. And the combination of IQ plus the other apps is what makes the tagline knowledge-powered CRMs so effective.

All right. Thank you.

I'm showing no further questions at this time. I will now turn the call back over to the speakers for any further or closing comments.

We are going to get back to work and get in with these integrators and do our darndest to get our arms around managing the closure rates and getting more dependable at forecasting those rates. The good news is that it is working, the integrators are adopting our solutions. We're doing a lot of joint selling. The pipeline is growing. We just need to get better at being more dependable on forecasting the closure rates and that is what we are off to do. So thank you, and we will talk to you in July.

Thank you. This does conclude this afternoon's teleconference. Please disconnect your lines and enjoy your day.