SWK Holdings Corp (SWKH) 2004 Q2 法說會逐字稿

Good afternoon, and welcome to the KANA software second quarter earnings conference call. At this time, all lines have been placed on the listen-only mode and the floor will be open for questions following today's presentation.

It is now my pleasure to turn the floor over to your host, Chuck Bay, CEO of KANA Software Sir, you may begin

Thanks. Hi, this is Chuck. I'm here with Michelle Philpot, our acting CFO, and with Tim Angst, our VP of Worldwide Sales and Services.

Before I start the call, though, Michelle has a statement she'd like to make for you

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, operating results, our long-term success, our product and product development efforts and characteristics of our market segments.

Actual events or results could differ materially from those described or anticipated in the forward-looking statements as a result of a number of factors, including: risks associated with our efforts to grow our sales, our reliance to 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 effects 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 the comments we provide today are still valid. Chuck?

Thanks. I hope you've all had an opportunity to review the press release we issued early this afternoon.

In a few minutes, Michelle's going to give some color and some details to the financial results and then we'll open the floor for questions. Our Q2 results were in line with our previously announced results, with one little exception.

A little over a million dollars in services revenue associated with one customer's maintenance contract has been deferred instead of completely recognized in Q2, and will be amortized over about the coming six quarters. I think Michelle can talk a little bit about that in detail if there's questions.

We feel that we've taken a more conservative approach on this revenue, which is consistent with our general policies on revenue recognition and deferral.

Obviously, the economic conditions remain very difficult for enterprise software vendors. We had a disappointing quarter with respect to our revenue generation.

Although we burned about $6 million in cash during the quarter and could burn that same amount in Q3, we've already taken the required steps to bring our operations in line with expected Q3 and Q4 bookings.

In other words, although KANA does not provide specific revenue guidance, we expect that the reduced Q3 booking levels already reflected in the First Call models will be sufficient to bring us to about cash flow break even for Q4.

Cash burn has been something that we've been focusing on very hard and we think it's a very critical issue; and bringing it to break even for Q4 on a conservative basis, we think, is a very wise move. As many of you know, KANA's already made the very difficult transition to an outsourced R&D model.

Six quarters ago, we began the outsourcing transition, which took about four quarters to complete. Over the course of the past eight weeks, we have adjusted our resource allocations in India and in China.

We're now very well positioned to be able to bring cash flow and GAAP profitability levels in line with our new bookings and revenue forecast. The very high leverage provided by our model has enabled us to preserve the significant software releases that are due and coming in the six to nine months, while also very quickly allowing us to adjust our cash flow and get profitability levels in reaction to recent market conditions.

This is very important to us, because a it allows us to maintain our significant technology and product leadership role in the SRM marketplace, while at the same time moving critical -- critical -- moving critically towards near-term cash flow generation and GAAP profitability.

On the bookings and operations front, we reached a significant milestone in the transition of our sales force from Tom Doyle to Tim Angst; and although Tom is still fully engaged with me in working with integrators and helping with large deals, Tim now has full responsibility for worldwide Sales and Service.

Over about the past 100 days, Tim has been reviewing all aspects of the KANA business model, the bookings pipeline, the forecasting mechanisms and integrator relations, and he can answer any questions with respect to those areas directly in today's Q&A, because he's here with us.

With respect to the sales side of operations, we again grew the pipeline of deals in Q2. This is a very important metric, which we track as a significant measure of the success of our model.

However, we're fully aware of the importance of returning to long-term capability with respect to revenue growth, cash flow, and profitability.

These are our most important business goals on the short-term and long-term basis, and I'm confident that we will show very quick progress with respect to all three of those areas.

On the integrator front, our relationships with IBM, [INAUDIBLE], Bearing Point and HCL all remain strong and all broadened this quarter. These relationships will be key to our success.

We firmly believe that as the CRM and CRM-related spaces continue to consolidate, the integrator relationships will grow in importance; and KANA, as you know, is well positioned to take advantage of that trend.

As a final note, we reached a very significant milestone this summer with respect to our SRM product suite. Our U.S. and international development teams released the first fully-integrated SRM product suite into the marketplace. As most of you will recall, KANA announced a little over a year ago that we were moving into service resolution management, or SRM, as it's commonly called.

This is adjacent to the CRM space. The primary difference is that instead of offering a broad suite of applications covering the CRM landscape, we have focused all of our new releases very intently on service resolution management resolutions.

All of our integrated partners are very excited about this movement, because it gives a new product offering to take in to their clients and boost the productivity and the ROI on any prior CRM investments their clients have made.

Our number one source of bookings at KANA in revenue over the past three years has been our knowledge management application, known as KANA IQ. We used IQ as the backbone of the SRM suite, and it's now the only knowledge-based SRM suite in the marketplace.

Plenty of smaller players are now following our lead and embracing the SRM market, which not only validates our strategy, but it helps create awareness in the market. We believe that our product lead in this space will continue to grow as we release additional versions in the coming year.

As the SRM market continues to attract more players, we believe that the difference between the KANA knowledge-based applications and the rest of the players' search-based products will become very important.

KANA has both search and knowledge-based technologies, but it looks like it will be quite a while before any other player obtains a complete suite with knowledge in their product. It certainly seems that technology -- search technology -- will become commoditized well before knowledge-based technology could be. At this point, let's turn to Michelle for some color with respect to the financial results

Thanks, Chuck. As Chuck noted, we were disappointed with the level of licensed revenue in the second quarter. Our quarterly revenues and operating results are difficult to predict and may fluctuate significantly from quarter to quarter, particularly because we rely upon booking a few number of large deals within each quarter.

We work closely with third party system integrators for the majority of our sales, and we sell enterprise CRM software; which, associated with a difficult economic environment, creates prolonged purchasing cycles.

Summarizing from our press release, total revenues for the quarter were $9.6 million, down from 13.3 million in the first quarter of 2004. On a GAAP basis, EPS came in at a loss of 22 cents per share or $6.4 million. Fully diluted weighted average shares outstanding at June 30th, 2004 were 28,939,000.

In terms of revenue breakdown, license revenue was $1 million and accounted for 11% of total revenues. Maintenance revenues were 7.8 million, or 81% of revenues, and professional service revenue was approximately 800,000, which represented 8% of revenues.

Our combined software license and maintenance constituted 92% of our total revenue this quarter, resulting in an overall gross profit of approximately $30.1 million, which yielded an overall gross margin of 71%. Despite our license revenue shortfall, we believe that KANA maintains one of the highest overall gross margins in the CRM space.

Our integrated line of business model gave us these higher margins. Our maintenance revenue remains strong, a testament to our large existing install base. During the second quarter, maintenance renewal rates were around 90%, in line with prior quarters. Existing customers accounted for the majority of our license bookings.

We also booked three deals with new customers during the quarter. In the second quarter, 68% of our revenue was from the U.S. with 32% coming from overseas.

There were no deals booked over $1 million in Q2, which resulted in an average transaction size of $136,000, down from $258,000 in Q1 of this year. Our strongest verticals continue to be financial services and communications.

Moving to our expenses for the second quarter, sales and marketing expense was 5.9 million or 61% of total revenue. This was down 600,000 from the prior quarter, primarily reflecting reduced commissions.

R&D expense, representing 53% of revenue at $5.1 million, was in line with the prior quarter. G&A expense, representing 23% of revenue, was $2.2 million, roughly in line with the prior quarter. We are pleased to show the results of many quarters of internal effort at scaling our operating model.

As compared to the second quarter of 2003, the sum of sales and marketing, research and development and general and administrative expenses have decreased by 28%. This reduction was weighted across the board in all operating line items, a result of our internal cost control.

Amortization of intangibles and stock based compensation for the quarter was 394,000. Looking ahead, we expect it to be approximately 300,000 in the third quarter and 100,000 in the fourth quarter of 2004. Our full-time head count to date is 205, including a total of 15 quota-carrying sales reps.

Moving to the balance sheet, cash and cash equivalents at the end of June was 21.7 million, down from March as a result of the revenue shortfall in the prior and current quarter, as well as changes in working capital.

Accounts receivable was down by 2 million from the first quarter, reflecting our reduced revenues and the timing of maintenance renewals.

DSOs at June 30th were 34 days, reflecting the high concentration of maintenance revenue this quarter, which is billed in advance. This was better than our target of 45 days.

Our quick ratio, defined as free cash and investments and net receivables, divided by current liabilities other than deferred revenue, was better than one and a half. Our working capital, excluding deferred revenue, was 14.6 million.

Total revenue at June 30th was $19 million, down from 21.4 million at March 31st, due to the reduced revenues, as well as timing of maintenance renewals. This concludes the financial highlights. Operator, let's move to the Q&A.

Thank you. The floor is now open for questions. If you do have a question, please press star one on your key pad at this time. Once again, to ask a question, it is star one. Please hold one moment while we poll for questions. Thank you. We have our first question coming from Chuck Goldbole from [INAUDIBLE] Capital.

Hi, thanks for taking my question. I have two questions.

One, can you comment on the change of order after this quarter to the situation around that, number one. And number two -- Chuck, it's great to hear that -- I mean, under these difficult circumstances that you're looking to cut some expenses to get to break even on conservative bookings for Q4.

Could you talk about, one -- I know you don't want to give bookings guidance, but some sort of direction on where that lies relevant -- relative to this quarter's results, last quarter's results, Q4 results, because those were sort of all over the place as far as bookings were concerned; and furthermore, what sort of cuts you intend to make, where at, and in what areas?

Okay. One is very simple.

In June, there was a cutoff date measuring market cap and equitability of some of the new 404 rules, and KANA came in under the -- under the cap, so -- our market cap was under 75 million, so we're not subject to some of the new requirements, which meant that our work with PWC was greatly reduced -- in other words, our fees were going to be greatly reduced. And in Silicon Valley, they are very resource-constrained.

It's -- this legislation has created an enormous amount for the workload for all the auditors, and because we were not going to be subject to the new stuff, we were -- we were advised that our odyssey alone could not justify the resource allocation that we were going to need.

So they said, let's break ways, we need to put all our resources on our bigger clients, and since you guys are not subject to the new rules because you're not above $75 million market cap, let's part ways -- and so we did.

So no disputes, no arguments, they just informed us that they don't have enough resources in the Valley to cover all their ties, and the small ones were going to let go. So we'll move on to a new outlook.

The second question, which relates to -- I think the essence of it was, how are we handling the bookings forecast, and it's sort of -- do we think it's different or do we have more confidence in it?

That I'll hold for a second -- and Tim Angst is here, so he can talk to you about how he approaches that. So I can tell you that I have an enormous amount of faith that Tim will exceed his numbers that he's committed to, because I've been watching him intently for about 100 days, as he's watching the company intently, and I think he has a great methodology.

The third piece of your question was cost containment. What we -- what I was referring to as our leveraged model allows us to move our research and development cost very significantly if we need to.

Now, as Michelle stated, she has instituted across the board increases in efficiency. Since the day she became acting CFO, we've probably improved about 15% across the board on the measures that she's instituted.

So there's no layoff, there's no specific, very giant change in any area, but every area is more efficient. And the biggest change would be in India and China, where we can much more easily increase and decrease expense flows. So we have decreased expenses now to the point where we can get out the releases in the next six months, nine months, and we think our product edge will enable us to do that without damaging our market position.

So I'd say, if you rank ordered them, most savings from R&D, then from sales and marketing and then from G&A but no giant -- no layoff required, just better efficiencies, freeze the head counts, cut into the programs across the board -- and Michelle's had both eyes on it for quite a while now.

So Tim, Q3, Q4 bookings forecast -- what do you see?

Yeah, so let me make a couple of comments. I've been with KANA now about 100 days, as Chuck mentioned, and feel the more I know about the company the more confident and comfortable I feel that we're positioned well and we're heading the right direction.

I think that there are a number of things I've been focused on since joining the company. and certainly some of them are driving across more consistent execution across the board; but from a booking forecast standpoint, I'm very comfortable and optimistic about the pipeline that we see and the work that we're doing with our key integrators and how we're targeting the field to drive some of the key deals toward conclusion.

So I'm confident, I'm comfortable -- you know, I'm very conservative by nature, but I think that the model that we're operating under, one of partnering tightly with integrators that help build pipelines, close deals, is a model that I'm familiar with from my days at Seibel, and I've seen it prove out well there, and so I'm optimistic that we're heading the right direction. We have sufficient pipeline to meet our commitments.

You referred in your question to the fact that we don't give guidance and we don't ;and we don't believe that we will return to giving guidance any time soon, given the current economic environment.

But if you look at the current First Call, if you look at the two analysts who adjusted their models earlier this month, you know, we're very confident that Q4, we could be cash flow break even, approximately, and never look back, because the changes that needed to be made are already made.

All the changes to the expense flows, the cash flows, the India/China contractors, the outsourcing model, the head count, that's all behind us now. So as we move forward, we're much leaner now.

Okay. And Tim, just a follow-up on your -- your comments regarding bookings and the partnerships you guys have.

You know, a company like -- a company of your size, is there a concern of not getting the sort of focus from the SIs that you'd like? And a story that comes to mind is that, you know, Onyx Software was the first one to have the sort of on-demand partnership with IBM, and nothing came of it. And then Seibel took it over and maybe there's a bit more happening. Is there a concern with KANA's size?

You know, since being here for 100 days now, you know I think my general impression is I'm -- I'm over -- you know, I'm overwhemed at support that we're getting from our integrators. I think that -- you know, certainly, the key integrators are very important relationships to us.

I think that we're a little bit different than most of the players in the industry in that we have completely dedicated our business model to allowing integrators to provide professional services capability that we need in implementing our customer solutions, so I think that tightens our relationship with many of them.

But I think that the message, the position, that we've got around -- service resolution management -- is one that resonates very well with our key integrators and they understand the intrinsic value in providing the solution to customers, and I think that's going to drive our relationship deeper --

The fact that, together, we are providing true value to our customers in the marketplace.

Thank you.

Thank you. Once again, if you do have questions, please press star one on your key pad at this time. One moment while we poll for questions. There appear to be no questions at this time. I would like to turn the floor back over to Mr. Bay.

Okay.

I guess in summary, I would say, you know, we've driven the stakes in the ground, we've got to get the cash flow positive, we've got to get the GAAP back to that GAAP profitability, so all the changes that we need to make, we think we've made. We have not handicapped our relationship with the integrators or our ability to release world class applications, and we have a lead in the SRM marketplace that we do not intend to surrender.

So we'll have a lot of measurable metrics in October for you, and I hope to talk to y'all then. Thanks.

Thank you. This does conclude today's conference. Please disconnect all lines and have a great day.