SWK Holdings Corp (SWKH) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the KANA Software third quarter 2006 conference call. My name is Onika and I'll be the operator for today.

At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded for replay purposes.

At this time, I would now like to turn the call over to Mr. Fields. Please proceed, sir.

Good afternoon, everyone, and thank you for joining us on the call today.

I'm excited about the opportunity to update you on Q3 as well as 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 you the 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 the result of a number of factors including risks associated with our efforts to grow 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 effects of uncertain economic conditions and 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 provided today will still be valid later in the quarter.

Now I'll turn the call back over to Mike.

Well, thank you, John.

We spoke to you at the end of 2005 and again at the end of Q2. 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 on each of these fronts today. I'd like to give you an update on these objectives as well as an update on our performance in the third quarter.

With regard to our first objective to become the leading provider of enterprise multi-channel customer service solutions, I'm pleased to report that in the third quarter, KANA received third party validation and recognition from Patricia Seybold Group's Quarterly Cross-Channel, Cross-Lifecycle Customer Service Product and Company Update. In this recent report, Mitch Kramer, Senior Vice President of PSG wrote that "KANA was our Q2 2006 star with excellent performance across-the-board," highlighting the Company's significant customer growth and substantive product activity and market leading financial performance.

In addition, further validating KANA's leadership in the multi-channel customer service market, the Company received two additional awards in the third quarter of the year bringing the total to eight awards for the year. In Q3, KANA Response was named a Trend-Setting Product of 2006 by KMWorld Magazine, marking the second consecutive year the Company's industry leading e-mail response management solution was awarded this distinction.

In addition, KANA has named the recipient of Frost & Sullivan's 2006 Product Line Strategy Award for its robust Web self-service solution and integrated multi-channel suite. In fact, the press release for that award was announced today.

KANA offers the most scalable integrated multi-channel offering available in the market today. We are committed to maintaining our lead in world-class multi-channel customer service solutions as evidenced by the release of KANA Suite 9 in Q3.

KANA Suite 9 expands the depth and breadth of KANA's multi-channel capabilities with significant upgrades to KANA Response, our industry leading e-mail response management applications, KANA ResponseLive, the Company's comprehensive solution for live chat and Web collaboration, KANA Contact Center, our universal agent desktop, and KANA IQ, the award winning knowledge base for agent assisted and Web self-service. The deep integration of these technologies delivers the most robust, multi-channel customer service solution in the market today.

KANA hosted its 2006 Worldwide User Conference last week in Boston. The event was well attended by customers, industry analysts and partners. Our strategic partner, IBM, was the platinum sponsor for the event.

Keynote addresses were given by J.D. Powers IV, Mark Greene, IBM's Vice President of their Financial Sector solution, John Ragsdale, Vice President of Research at SSPA. Customer satisfaction and the voice of the customer were the main topics on the agenda.

KANA had over 120 customers attend this event and early feedback has been extremely positive. In fact, one customer quoted as saying, "it is clear that KANA's management has changed the Company to become more customer focused."

Regarding our second goal of developing and recruiting the best people in the industry, KANA announced in Q3 the hiring of Jay Jones as Chief Administrative Officer. Jay will be responsible for overseeing KANA's general counsel's office, human resources, information technology, facilities, purchasing and order fulfillment, providing leadership necessary to successfully manage the Company's administrative operations and business processes in compliance with Sarbanes-Oxley guidelines.

Jay has over 20 years experience in leading software companies business operations and prior to KANA held similar positions at Symantec, VERITAS and Oracle.

In addition, Jay, excuse me, in addition, KANA announced the hiring of Danny Turano as Vice President of our newly Formed Global Financial Services vertical. You might remember I mentioned that we were going to create this in our second quarter report.

Danny will build a sales team that will focus specifically on financial services accounts worldwide. Over a 25 year career, Danny has successfully led sales and marketing activities at some of the most successful software companies in the world including Oracle and Siebel Systems.

KANA also announced in September that Chris Hall has rejoined the Company as Vice President of Product Strategy. Chris will have the responsibility of product strategy and direction and will also lead the product marketing organization.

Chris spent seven years at KANA prior to his departure in October of '05 and he brings extensive experience in call center and customer service technology back to the Company. He's also a noted speaker in the area of customer service.

It is important to note that some of the best people in the industry happen to reside within our strategic partner, IBM, and in developing our relationship with IBM over the last six years, KANA has defined a strategy for pursuing selected industry verticals along with major customer service outsourcing opportunities in partnership with IBM. Our successful work within the financial services vertical at IBM is what led to the formation of a KANA sales team focused within this vertical.

Last Thursday, we had the opportunity to speak at IBM's Financial Services Global Leadership meeting which consisted of the managing directors for IBM's top worldwide financial services accounts across retail banking, capital markets and insurance.

We were the only ISV that was given the opportunity to speak and it's through these key relationships is what led to our significant win at Cigna in Q3 which we will discuss later. It has been instrumental also in increasing our pipeline for the fourth quarter and beyond.

In order to maximize the opportunity potential as in Q2, we share with you our plans to increase KANA's sales team from 14 quota carrying reps at the end of 2005 to around 30 quota carrying reps by the end of 2006.

We've made great progress in this initiative, including our newly formed Boseman, Montana office which is the home of our new director of inside sales and two new inside sales managers. This team will build an organization to focus on lead generation and our on-demand offering which we plan to have a major product launch in Q1 of '07.

Additionally, we've hired three new field representatives bringing today's worldwide quota carrying headcount to a total of 21. We will continue to hire additional quota carrying reps in Q4 in the financial services vertical, geographical territories, as well as inside sales.

In regards to our backshoring effort, we have successfully moved all development and engineering back in house in our offices in Menlo Park, California and Manchester, New Hampshire. We're in the process of moving our customer support organization back onshore and should have this completed by the end of November. In addition to Menlo Park and Manchester, we also have customer support teams in Amsterdam and The Netherlands.

Our third objective was to operate with growing the sustainable revenue, profit in cash. Q3 shows good progress towards this goal. Revenues for the third quarter were $13.1 million reflecting a 20% growth over prior year, including in this is 174% growth in licensed revenue.

KANA signed six new customers in Q3 including Cigna, WorldVision, Amadeus, Martha Stewart Living and expanded business with over 28 existing customers including Cingular Wireless, Best Buy, O2 and MetLife.

Additionally in Q3, the Company had two orders for license plus additional maintenance that were each over $1 million. In particular, KANA experienced strong demand for its agent assisted Web self-service solution, KANA IQ, which accounted for 61% of the total orders for the quarter.

Importantly, we continue to grow our alliance partnership with IBM as evidenced by the significant win at Cigna in Q3. The Cigna transaction is a multi-year, high seven-figure license and initial maintenance transaction for KANA IQ. IBM will be transforming the customer service operations at Cigna and KANA is a key component to drive significant business value for the client.

We continue to see substantial growth in our pipeline of joint opportunities in both North America and EMEA with IBM. We are very enthusiastic about our new business opportunities, our growing pipeline, and our new hires for the KANA team.

Now I'd like to turn it over to John to discuss our financials in more detail.

Thanks, Mike.

Looking at new orders for license and initial maintenance, what we call LIM, KANA closed 40 deals in the third quarter. Excluding the smaller typically follow-on additional seat deals the average selling price on the LIM new orders over $100,000 was $956,000, the highest ASP in over four years.

This ASP calculation includes two deals over $1 million. One each from a new and an existing KANA customer.

Total license, maintenance and service orders in both our second quarter and third quarter of 2006 have been exceptionally strong. Our nine-month to date total orders for 2006 already surpasses the total orders received in all of 2005.

Turning to the income statement as Mike mentioned earlier, KANA's total revenue for the quarter ended September 30, 2006 was $13.1 million, an increase of 20% over a year ago. License revenue for the third quarter of 2006 was $4.4 million, an increase of 174% over the year ago quarter.

The third quarter's license revenue was at the low end of our expected range because we were unable to recognize any revenue from a large order that we received during the quarter from a new customer. We are working diligently with IBM such that we could possibly deliver a portion of these licenses from the large multi-year order in the fourth quarter.

KANA's total revenue for the nine months ended September 30, 2006 was $39.1 million, including license revenue of $13.1 million. These revenue numbers represent increases of 23% and 139% respectively from the total and license revenue numbers reported for the nine months ending September 30, 2005.

Looking at our business geographically, the U.S. contributed 56% of total revenue in the third quarter and 69% for the nine months ending September 30, 2006. These percentages were down slightly from the 69% and the 70% for the same respective periods ending September 30, 2005.

Given the significant increase in 2006 over 2005 revenues that we've had year-to-date, these percentages reflect the growing strength in both our domestic and our EMEA sales operations.

As a reminder, please note that KANA excludes certain non-cash items for the purposes of internal recording. 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 from 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 three are the FAS 123R stock option compensation expense, registration rights penalties, and warrants liability expenses.

Turning to the gross margins, our overall gross margins were 75% in the third quarter compared to 78% in the prior quarter and 74% in the year ago quarter. The slight increase in gross margin versus the same quarter last year is due to having a higher license gross margin offset by a lower services gross margin.

The lower services gross margin is due to a one-time services revenue recognized in the third quarter of 2005.

In the third quarter of 2006 our license gross margins were 81% versus 87% in the prior quarter and compared to 63% in the year ago quarter. This is the result of a mix of products, the leverage we gained with higher license revenues and lower OEM royalty expenses.

Next, turning to operating expense lines, I'm pleased to report our efforts to align our costs and reallocate where we spend our resources are continuing to yield the desired results. For the third quarter of 2006 sales and marketing expenses decreased to $4.1 million compared to $5.1 million in the prior quarter and roughly in line with the $4.3 million in the third quarter of 2005.

As a percentage of revenue sales and marketing represented 32% in the third quarter of 2006 versus 35% in the prior quarter of 2006 and 39% of revenue in the third quarter of 2005. The absolute dollar decrease in sales and marketing expenses this quarter versus prior quarter was due primarily to lower commissions, bonuses and discretionary and marketing costs.

For the third quarter of 2006, R&D expenses were $2.7 million, an increase of 26% from $2.1 million in the prior quarter and roughly in line with the $2.9 million of R&D expense in the third quarter of 2005. The significant increase in R&D expenses from the prior quarter reflects increased employee expenses and contractor consulting costs.

R&D expense was 21% of total revenue in the third quarter of 2006 compared to 15% in the prior quarter and 27% of revenue in the third quarter of 2005.

For the third quarter of 2006 G&A expenses were $1.8 million as compared to $2.4 million in the prior quarter and $2.2 million in the quarter a year ago. The primary reason for the decrease in G&A expenses was the reversal of an accrued state tax expense that had been expensed since the first quarter of 2005. The Company received a favorable ruling in our favor.

This one-time only expense reduction was offset by a higher professional services expenses related to the filing of our 2005 10-K, first and second quarter 2006 10-Qs and an S-1 registration during the quarter.

As a percentage of revenue, G&A was 14% in the third quarter of 2006 as compared to 17% in the prior quarter and 21% of revenue in the third quarter of 2005.

The Company recorded third quarter 2006 non-GAAP net profit of $1.2 million. This is calculated by adjusting KANA's GAAP net loss of $582,000 by adding back the third quarter non-cash accounting charges for stock-based compensation expense measured in accordance with FAS 123R and the final registration rights penalty.

As I noted in the last conference call, we booked a $1.6 million FAS 123R expense during the third quarter 2006 due to the first grant of options since 2005.

KANA had a nine month non-GAAP profit of $3.3 million calculated by adjusting the Company's GAAP net loss of $2 million by adding back the three non-cash accounting charges for stock-based compensation expense measured in accordance with FAS 123R, the value of the registration rights penalties and the warrant liability expenses.

On a GAAP basis, KANA reported a net loss of $582,000, or a fully diluted loss of $0.02 per share for the third quarter of 2006. This compares to a GAAP net loss of $383,000, or a loss of $0.01 per share for the prior quarter and a GAAP net loss of $1.3 million, or a loss of $0.04 per share for the quarter ended September 30, 2005.

For the nine months ended September 30, 2006 the Company reported a GAAP net loss of $2 million, or a loss of $0.06 per share versus a GAAP net loss of $17 million, or a net loss of $0.57 per share for the nine months ended September 30, 2005.

Turning to the balance sheet, unrestricted cash, net of draws against our bank line, increased to $4.6 million on September 30, 2006 up from $1.6 million at the end of the prior quarter. At September 30, 2006 KANA's outstanding bank line of credit was zero.

As we indicated on our August call, during July, we paid off this line in full. Now that the line of credit is fully paid off, we have the full $8 million at our disposal should we need it.

Based on our current revenue expectations for the next 12 months, we believe that our existing cash and cash equivalents are sufficient to meet our working capital and capital expenditure requirements.

Day sales outstanding for the third quarter was 51 days compared to 58 days for the prior quarter. At September 30, 2006 deferred revenue was $16.2 million, an increase from the $14.5 million reported for the prior quarter. As we have indicated in the past, deferred revenue is primarily comprised of maintenance.

Moving to headcount. At September 30th, the Company had 153 full-time employees, an increase of 22 from the 131 employees we had at June 30th. Included in these numbers are 20 and 18 quota carrying sales reps respectively.

Finally, a quick housekeeping manner. We are awaiting an in imminent okay from the SEC on an S-1A filing to register the stock we issued in the two PIPES last year plus the registration rights penalty shares. We answered two questions last week that we think is sufficient for SEC approval.

When that does occur we believe that NASDAQ is only waiting on this SEC approval before NASDAQ approves KANA moving to the OTC Bulletin Board. Then the gating item for us to move up to the NASDAQ Small Cap market is having a $4 share price for 90 consecutive days. A $5 stock price is required for the NASDAQ National market.

Now I'll turn the call back over to Mike.

Thank you, John.

As you can see, we continue to make great progress towards the goals that we've outlined and I have confidence that we have the solutions, the people, and the focus to continue to execute to our defined objectives. The entire organization is focused on reaching sustainable, profitable, and profitability and maximizing shareholder value.

Now I'd like to speak to our guidance. We are reaffirming our previous guidance that we continue to expect total revenues for 2006 to range between $56 million and $58 million. This represents a growth of 30 to 35% over 2005 total revenue.

This is fueled by the demand we're seeing for our multi-channel customer service solutions with new and existing customers and also the work we're doing with our integrated partners.

Before I turn it over for questions, John and IR also joined today by Marchai Bruchey. Marchai's our Chief Marketing Officer. And operator, I would like to turn it over to you for a few questions.

Thank you. [OPERATOR INSTRUCTIONS] Your first question comes from the line of Karen Haus with WR Hambrecht. Please proceed.

Thanks very much.

Mike, I was hoping that you might be able to give us a little bit more color on your guidance. Specifically, could you give us a little more color on sort of what the license component for the target for the year is?

And also just kind of maybe you could walk us through sort of some of the mechanics when it comes to some of the larger transactions and how the revenue will flow into the income statement. That would be great. Thanks.

Certainly, Karen. We haven't given any specific guidance outside of our total revenue guidance for the year and we'd like to leave it there, however, I would like to point out that we have several large transactions that we're working in the fourth quarter that are into seven figures each that we have already won the business and technical decision from the companies we're talking to, and right now, we're dealing with procurement and contracting in order to close them.

And importantly, we also have a number of transactions that are within the half a million to million dollar size that were in the same opportunity base, so we're extremely confident about our ability to meet our guidance in the fourth quarter.

Great. And then just as you look forward, could you -- is it fair to say that the pipeline is stronger today than it was three or six months ago?

Absolutely, Karen. Not only is it stronger but it continues because of the new sales reps we've hired, we're also starting to see the pipe opportunities spread out more evenly amongst the salesforce which is what's exciting to me. The few things exciting to me about the pipeline, number one is that our sales reps coming into the business and finding success in selling to our existing customers and even some of our new customers very rapidly.

We've added a few new companies, as you know, a few new sales reps as we outlined and in a couple of cases over the last couple of months, they've already performed by selling business directly into their respective territories. So we're starting to see the pipeline opportunities spread around not just the reps in the U.S. but around the world.

The other exciting thing that we've seen in the last three quarters almost a 50% increase in the pipeline as it relates to opportunities between that $250,000 to $1million size. And really, that's the bedrock of the business as we see it for our premise base solutions and that's what's really exciting to me, where we can get to a place of expecting that our sales reps are going to do one or two $250,000 to $500,000 transactions a quarter and then one large transaction a year, so we're excited about how our large opportunity base continues to grow, the above $1 million size, but the strength we're seeing in the 250 to $1 million is really quite amazing.

And for the 250 to $1million deals, do they tend to be with existing customers or do they tend to be with new customers and are they primarily, maybe you could just give us some color on kind of where you're seeing strengthen the deal sizes of that nature.

I would say that if you asked me that question after Q1, I would say it would be about 75 to 80% of it were existing customers, but now, it's more like 50/50 between existing and new customers.

You know, there are two things that happen to us and to our sales reps. It's because they have a strong existing customer base to sell to and we focus them ongoing into their base to cross-sell and up-sell opportunities.

Two things happen. One is they source and receive success they sold something and on top of that, they got more educated about the business value the technology brings to their customers which, frankly, has made them stronger in selling competitively.

So that's why we've started to see an increase in new business opportunities in our pipeline because of the sales reps, I believe, along with all of the other aspects that we're giving them with our marketing programs and other campaigns that we've been running, are smarter about how to position our technology against competition.

Great. Thanks very much. I'll let someone else ask questions.

[OPERATOR INSTRUCTIONS] At this time, there are no questions in queue. I would now like to turn the call over to Mike Fields for closing remarks.

Well, from a closing standpoint, I thank you all for your time and attendance and attention. We are extremely confident going into the fourth quarter. We most certainly expect to meet our obligations to our stakeholders and the guidance that we've given you all relevant to what our business will be.

We are formulating our plans for 2007 and we will be prepared to give you more specific guidance in our next call at the end of Q4 on 2007. And as I had committed to you all, our guidance perspective will broaden with what we offer at the end of the year.

So again, thank you for your time and attendance and now we're going to go get back to work. Bye now.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Thank you and have a good day.