SWK Holdings Corp (SWKH) 2006 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the second quarter 2006 KANA Software earnings conference call. [OPERATOR INSTRUCTIONS] At this time, we'll turn the call over to your host, Mr. Michael Fields, Chairman and CEO. Please proceed sir.

Well, hello, everyone. Thank you for joining us on this call today. I know it's been some time since we've had a call like this and I'm excited about the opportunity to update you on the second quarter, as well as to update you on other Company activities and initiatives.

Before I get started, I'd like to turn the call over to John Thompson, our CFO, who will give the normal Safe Harbor provisions. John?

Again, I will be giving the customer Safe Harbor provisions. On this call, we will be making forward-looking statements regarding anticipated events and the future performance of KANA. Including statements regarding our expected revenues, margins, expenses, profitability, cash and cash flow. As well as expected growth, relationships with customers and integrators, our long-term success, new hires, 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 on large orders to meet our expected sales in a given period, our sales cycle, our ability to manage our expenses and finance our operations, competition, market acceptance of our products or services, the affects 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.

The forward-looking statements for this call address our view of the situation today and no one should assume that the comments we provide today will still be valid later in the quarter. Now, I will turn the call back over to Mike.

Thank you, John. When I spoke to you at the end of 2005, I laid out three key objectives for the Company. The first was to become the leading provider of enterprise multi-channel customer service solutions. The second, was to develop and recruit the best people in the industry. And the third was to lead the Company to operate with growing and sustainable revenue profit and cash. I'm proud to say that KANA has made significant progress in each of these fronts. And today, I'd like to give you an update on these objectives, as well as an update on our performance in Q2.

In regard to our first objective of becoming the leader provider of enterprise multi-channel customer solutions, I'm happy to report that in the second quarter, KANA had received significant third party validation and recognition from Forrester Research, one of the most respected industry analyst firms. In May 2006, KANA was positioned as the leader in the Forrester eService Wave Report. KANA was recognized for its focus on the multi-channel experience and for having the broadest and deepest eService suite there is in the market. We received the top scores in 22 categories in the report, resulting in KANA's overall placement as the clear, eService market leader for the second consecutive year.

In addition, further validating KANA's leadership in the multi-channel customer service market, the Company received six awards in the first half of the year alone, including two in Q2. In Q2, KANA Response was named the recipient of the Customer Interaction Solutions magazine magazine, CRM Excellence Award for 2006, making the seventh consecutive year KANA was awarded this distinction. Also based on overwhelming support from KANA customers, KANA IQ was recognized as the Best Knowledge Management Solution in EMEA from ContactCenterWorld 2006 Members Choice Award.

KANA offers the most scalable multi-channel offering available in the market today. In Q2, we released new versions of our existing product line, introducing KANA IQ 9.1, which takes our award-winning knowledge base to new levels. We also introduced new releases of our industry-leading email management system, Response and our chat cobrowse product ResponseLive. The deep integration of these technologies brings the most robust, multi-channel customer service solutions in the market.

Regarding our second goal of developing and recruiting the best people in the industry, we've added a couple of industry veterans to the KANA management team. In January, we announced that Bill Rowe, whom I've worked with for 20 years, has a proven track record of exceeding quota, has joined the Company to run sales for the Americas. In February, we added Bill [Freichtman] as VP of Finance, reporting to our CFO John Thompson, and leading our effort in finance. In the near future, we will announce the establishment of our financial services vertical sales team, that will also be managed by another seasoned veteran who will join the Company later this month.

It is important to note that some of the best people in the industry reside within our strategic partner IBM. In developing this relationship over the last six years, KANA has defined strategy for pursuing select industry verticals, along with major customer supported outsourcing opportunities. This work has resulted in several key wins to date and a strong pipeline going forward. In order to maximize the opportunity potential, we have plans to increase KANA's sales team from 14 quota-carrying reps at the end of 2005 to around 30 quota-carrying reps around the end of 2006. This will give the Company the ability to train new sales hires for 2007.

This increase in sales will help our strategy of focusing our efforts within our existing customer base. Along with increased resources, we are also focused on the majority of our marketing spend to reconnect with KANA's customer base through our customer advisory boards, regional user groups and our Worldwide User Conference being held in Boston on October 22 through the 25. We have had a very enthusiastic response from our customers for attendance at these events, which further demonstrates our commitment to KANA.

Our third objective was to operate with growing and sustainable revenue profit and cash. Q2 was a tremendous milestone quarter for the Company. Today, KANA filed its 10-Q for the second quarter of 2006 within the regulatory time frame. And we achieved positive EBITDA for the quarter as well. We are working diligently with the OTC to relist on the bulletin board as soon as possible.

Revenues for the second quarter were 14.5 million, above the high end of our preannounced range. KANA signed 11 new customers in Q2 including; PricewaterhouseCoopers, Macrovision Corporation and TracFone Wireless. And we also expanded business with over 30 existing customers, including; COX Communications Inc., Pentagon Federal Credit Union, Rail Europe Group and UBS PaineWebber Additionally, KANA in the second quarter had two licenses transactions and one maintenance renewal transactions, that were were each over $1 million.

Importantly, we have strengthened our alliance partnership with IBM with several transactions that closed in the first half. And seeing substantial growth in our pipeline of joint opportunities. We are very enthusiastic about our new business opportunities, our growing pipeline, both direct and with IBM, and the new hires to the KANA sales, hiring, marketing, and development teams. Now, I would like to turn it over to John to discuss the financials in more detail.

Thanks Mike. Looking at new orders for license and initial maintenance, what we'd call LIM, KANA closed 45 deals in the second quarter. Excluding the smaller, typically follow-on additional seat deals, the average selling price on the LIM new orders over $100,000 was $781,000, the highest ASP in four years. This ASP calculation includes the two deals over $1 million. One from an existing customer who purchased additional licenses, and one from a new KANA customer.

In total, five new customers are included in these deals over $100,000. As Mike mentioned, we also closed the seven figure maintenance renewal with an existing customer, which is not included in this ASP calculation. This strong customer momentum is reflected in our financial results.

Turning to the income statement, as Mike mentioned earlier, KANA's total revenue for the quarter ended June 30, 2006, was 14.5 million, an increase of 27% over the prior quarter and an increase of 37 -- excuse me, 36% over the year ago quarter. The license revenue for the second quarter of 2006, was 5.9 million, a sequential increase of 106% over the prior quarter and an increase of 150% over the year-ago quarter. This is our fifth consecutive quarter of total revenue growth. KANA's total revenue for the six months ended June 30, 2006, was 26 million, including license revenue of 8.8 million. These revenue numbers represent increases of 25% and 125% respectively from the total and license revenue numbers reported for the six months ending June 30, 2005.

Looking at our business geographically, the U.S. contributed 75% of total revenue in both the second quarter and the six months ending June 30, 2006. This was up slightly from the 73% and the 70% for the same respective periods ending June 30, 2005. As a reminder, please note that KANA excludes certain non-cash items for purposes of internal reporting. Management believes these non-GAAP financial measures provide a more accurate and meaningful basis for analyzing the Company's current performance and also relative to prior historic performance.

Specifically, while gross margins, sales and marketing, R&D, and G&A expenses currently include the non-cash FAS 123R stock option compensation expenses in our GAAP presentation of these items as of January 1, 2006; I will exclude these non-cash compensation expenses in the following discussion so that the comparisons to 2005 are more accurate. As an added reminder, please note that in my non-GAAP net profit discussion that follows, I will exclude three non-cash expenses. These are the FAS 123R stock option compensation expenses, as well as the non-cash registration rights penalty paid in common stock and the one-time warrant liability expense shown below the line as part of other expense.

Turning to gross margins, our overall gross margins increased to 78% in the second quarter, compared to 75% in the prior quarter and 76% in the year-ago quarter. The increase in gross margin is primarily due to having a larger ratio of license to total revenue in the quarter ended June 30, 2006. License revenue carries with it a higher gross margin percentage than services do. Our license margins increased to 87% versus 79% in the prior quarter and compared to 65% in the year ago quarter. This is the result of replacing one OEM for another with lower royalty costs, the mix of products, and the leverage we gain with higher license revenues.

Next, turning to operating expense lines, I'm pleased to report our efforts to right size KANA, that is to reallocate where we spend our resources, have yielded the desired results. For the second quarter of 2006, sales and marketing expenses increased to 5.1 million, compared to 3.6 million in the prior quarter and 4.3 million in the second quarter of 2005. As a percentage of revenue, sales and marketing represented 35% in the second quarter of 2006, 31% in the first quarter of 2006 and 40% of revenue in the second quarter of 2005.

The absolute dollar increase in sales and marketing expenses this quarter is due primarily to the higher sales commissions related to our higher license sales. For the second quarter of 2006, R&D expenses were 2.1 million, a decrease of 11% from 2.4 million in the prior quarter and a decrease of 36% from 3.3 million in the second quarter of 2005. The significant decrease in R&D expenses from a year ago reflects the back shoring of outsourced software development, primarily from India back to the United States. After the major rewrite of much of KANA's software had been completed by the outsourced engineers. As a percentage of revenue, R&D decreased to 15% in the second quarter of 2006 from 21% in the prior quarter and from 31% of revenue in the second quarter of 2005.

For the second quarter of 2006, G&A expenses were 2.4 million, as compared to 2.0 million in the prior quarter and 2.8 million in the quarter a year ago. The primary reason for the increase in G&A expenses from the prior quarter was higher employee related expenses. And the primary reason for the decrease in G&A expenses from a year ago was lower audit related expenses. As a percentage of revenue, G&A decreased to 17% in the second quarter of 2006 from 18% in the prior quarter and from 26% of revenue in the second quarter of 2005.

The Company had its second quarter 2006 non-GAAP net profit of $1.7 million. This is calculated by adjusting KANA's GAAP net loss of $383,000 by adding back three second quarter non-cash accounting charges. Specifically, $1 million for the value of the registration rights penalty, $810,000 in stock-based compensation expense measured in accordance with FAS 123R, and a warrant liability expense of $212,000. Of the 810,000 in stock-based compensation expense, $57,000 was recorded in services cost of sales, 299,000 in sales and marketing, 187,000 in R&D and $267,000 in G&A expenses.

Similarly, KANA had a six month non-GAAP profit of 2.1 million, calculated by the adjusting the Company's GAAP net loss of 1.5 million by adding the back the three, six month non-cash accounting charges of $1.8 million and stock-based compensation expense measured in accordance with FAS 123R, the one-time $1 million for the value of the registration rights penalty and a warrant liability expense of $774,000. Of the 1.8 million in stock-based compensation expense, 131,000 was recorded in services cost of sales, 657,000 in sales and marketing, 408,000 in R&D, and 570,000 in G&A expenses.

On a GAAP basis, KANA reported a net loss of 383,000 or a fully diluted loss of $0.01 per share for the second quarter of 2006 based on approximately 34.3 million shares outstanding. This compares to a GAAP net loss of $1.1 million or a loss of $0.03 a share for the prior quarter and a GAAP net loss of 1.9 million or a loss of $0.06 a share for the quarter ended June 30, 2005. For the six months ended June 30, 2006, the Company reported a GAAP net loss of $1.5 million or a loss of $0.04 per share for the six months ended June 30, 2006.

This the versus a GAAP net loss of $15.7 million or a net loss of $0.54 per share for the six months ended June 30, 2005. While we believe that KANA is on the verge of GAAP profitability, we will book a large FAS 123R expense in the third quarter 2006 due to the ramping of options for the first time since March 2005. This large non-GAAP expense will make GAAP profitability harder to achieve this quarter.

Turning to the balance sheet. Nonrestricted cash was 3.6 million at June 30, 2006, in-line with our nonrestricted cash at the end of the first quarter 2006. The decrease of 2.6 million in nonrestricted cash from 6.2 million at December 31, 2005 to the current levels, was due in large part to cash being used to reduce amounts payable -- excuse me, to reduce accounts payable plus accrued liabilities by 3.7 million during the first quarter. On June 30, 2006, KANA's outstanding line of credit balance was 2.0 million, a reduction of 5.9 million from the 7.9 million outstanding line of credit that we had at the end of the first quarter 2006.

I'm also pleased to say that during the second quarter of 2006, we realized positive cash flow from operating activities of $182,000. During the month of July 2006, KANA collected approximately $8.4 million of receivables from customers. However, the net cash received by KANA was 6.4 million after we elected to pay down the remaining 2 million on the line of credit, which is now fully paid off. Based on these events, our cash at the end of July 2006 was $4 million, after the 2 million line of credit was entirely paid off and removed as a current liability. Now that the line of credit is fully paid off, we have the full $8 million at our disposable.

Based on our current revenue expectations for the next 12 months, we believe that our existing cash and cash equivalents are sufficient to beat our working capital and capital equipment -- capital expenditure requirements during June -- through June 30, 2007. At the end of the second quarter 2006, our quarter ending net accounts receivable was 9.3 million, an increase of 3 million from the 6.3 million on March 31,2006, reflecting the increase in order and revenue activity in the second quarter. As I mentioned previously, we collected 8.4 million of these amounts last month.

Day sales outstanding for the second quarter was 58 days, as compared to 49 days for the prior quarter. This also reflects the large receivables at June 30, of which we have made significant collections in July. At June 30, 2006, deferred revenue was 14.5 million, an increase over the 14.1 million reported for March 31 of this year. Moving to head count, at June 30, the Company had 131 full-time employees, an increase off eight from the 123 employees we had at March 31. Now I'll turn the call back over to Mike.

Thank you, John. As you can see, we've made great progress towards the goals that we've outlined and I have confidence that we will have the solutions, the people, and the focus to continue to execute on our defined objectives. I'm very proud of our organization and the entire organization is focused on reaching sustainable profitability and maximizing shareholder value.

Now, I'd like to speak to our guidance. Based on the demand the Company is seeing and anticipating for its multi-channel customer service solutions from new and existing customers as well as our integrated partners, KANA expects the total revenues for 2006 will range between 56 million and 58 million. This represents a growth of 30 to 34% over 2005 total revenues. Operator, I'd like to turn it over to you for questions.

[OPERATOR INSTRUCTIONS] We'll take our first question from Karen Haus.

Thanks very much and congratulations on a very strong quarter. I was wondering if you could just -- I actually have two quick questions. One, in terms of the guidance, do you have a targeted breakdown for license and service contribution outlined? Or how should we be thinking about some seasonality in Q3 and perhaps in Q4?

Karen, thank you very much for your comment, firstly. I would say that this point, we wanted to maintain the guidance on the total number. Although from a business standpoint, we are expecting to see continued growth quarter over quarter in the numbers that we have presented. We think -- in all aspects of our business, I might add. So we're really positioned, we think, to do well on the next two quarters.

Fair enough. Do you expect that their -- do you expect to see some traditional seasonality in Q3 or Q4? Or are you pretty comfortable that the same kind of momentum you're seeing today will last throughout the rest of the year?

We're comfortable about the rest of the year, as we've defined in our guidance.

Great. And just one final question and that is about the financial services vertical sales team. Do you have expectations about perhaps focusing on some other verticals, or are you going to start with financial services and build out from there?

We'll be opportunistic about it. We've been very successful in a number of specific verticals. Financial services has been a successful vertical for us and we believe that by putting focus on this with a sales team we can see that accelerate. We'll see how that model works and we'll look to add others in the future.

Great, thanks very much and congratulations again.

And we'll take our next question from Greg Speicher, Moss Creek Capital.

Very good quarter also, I'd like to add my congratulations there. So you want to hire 16 salespeople this quarter. How comfortable -- this year, I'm sorry. How comfortable are you that you'll be able to do that?

We feel very comfortable. We're sharing from a lot of salespeople in the market that are interested in our Company and we're looking at sales hires around the world, so it's not all concentrated in one location.

So Asia might be an area, even?

Yes, of course. We believe there's a great market potential for us there as well and we will gradually grow our sales and support capabilities in the A-Pac region.

Talking about from a high level, are customers starting to add the IQ to existing packages, or are they buying the whole thing? How is it going from a sales procedure? How have you changed that over the past year?

Well, we find that customers also look at our solution based on where their needs are and they look at how they implement this solution over time. They typically have started with things such as the email Response product and Response. They'll then look at how they might want to do chat collaboration. If they have a major call center, of course, having the knowledge base is going to be very important with them and they'll start there. In both cases with the drive toward Web self service. We find the customer drives where they want to start. And the great thing for us, we feel is that we have this integrated multi-channel solution that allows the customer to make a decision on where to start based on their business demands. But also gives them confidence that they'll be able to cover the entire range of customer service with our technology.

And last question, how are you seeing the competitive situation changing this year, with a lot of mergers and acquisitions?

Clearly, there are -- we're in the high-tech business, there are mergers and acquisitions. But there's no one in the market that has the depth a breadth and scalability of technology that we have for the customer service marketplace. We see competition in certain aspects of it and features of it. But we think if we continue to focus on -- we offer an opportunity for a customer to start where they want, how they want, but then be able to grow to a total solution for customer service that covers Web self service, email, chat, cobrowsers as well as the call center. We think our competitive position is very secure.

Excellent, thank you very much.

[OPERATOR INSTRUCTIONS] We'll take our next question from [Winder Hughes] of Hughes Capital.

Winder Hughes, but the name's never done right but that's okay. John, who wrote that script for you because that must have been long and painful?

It wasn't so bad, Winder.

Okay. Well, we're thrilled and we're giddy about these results. I know that you guys are having a meeting up there this week with IBM and so my question really is two-fold. A) How big do you really feel that this market is that you're now seeing? Because you guys are still fairly small, your license revenue was running at, let's just call it, a sub-$50 million run rate. And you have these other outfits out there, whether it's Mercury Software, some Business Objects, and these are mid-tier firms that end up doing $4 to $500 million a year in revenue. So how big do you see this market, A. And then B) Within IBM, how would you characterize that relationship? And how big might that revenue be at some future point steady state down the road?

Sure. Well, thank you for your comments, Winder. First, I would say to you that we would find it very difficult to try to forecast on how big we can this market to be. But I firmly believe the market opportunity will one of significant growth. And the reason for that has to do with how customers are beginning to understand the need of driving their business through customer service. In a world where the concept of the commoditization of everything, real business differentiation nowadays, particularly with companies that have millions of customers. Real business differentiation is taking place on the technology side when it comes to delivering service to their customers. Doing it in a cost effective manner and doing it in a way that the experience that the customer receives is considered to be important enough for that customer to stay with that vendor.

We deliver technologies that help our customers realize that benefit. And as long as we do that and continue to show them how they can drive the cost of customer service down by moving more towards Web self service and e-mail type activities, by ensuring the productivity and easy of training of their call center agents. As we do that, the need grows and we're seeing that within our existing customer base today. Clearly, our first objective, as I stated a year ago, was to get the Company in a position where it can start on a path of sustainable revenue profit and cash. And we are doing that now. And it allows us now to put in place the kinds of programs to go take what we believe is a growing substantial market.

Now with regard IBM, we have a great relationship, primarily because IBM believes what I just said. That there is major opportunity for them with customers that are looking to ensure a customer experience by their customers. And IBM supplies technologies and services that benefit the customers in reaching those goals. Our technology matches very well with the kinds of professional services and products that IBM offers into that marketplace. So, we think that this is a growing market that will reach significant heights in the technology business.

So, would it be fair to say that what you have with IBM, that would be on the same scale as Siebel was with them eight years ago?

Well, we are a partner with them tier 2 overperforming with the mutual code of responsibilities that we have with them. When we reach the level of scale and performance that Siebel had with IBM, is something the future will tell us. But I will tell you that I believe from the discussions I've had with IBM executives that this relationship is important to their business strategy and it most certainly is important to ours.

Thank you, we believe.

I'm showing no questions at this time. I'll turn the call back over to management for closing remarks.

I would like to thank everyone for your time and attention. We are very excited about the future. We believe that we have people, the technology and the partnerships to continue to a leader in this market and to be one of those organizations that helps our customers achieve their goals of improving and growing their customer experiences. Thank you for your time and attention and we look forward to talking to you again next quarter.