SWK Holdings Corp (SWKH) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2006 KANA Software earnings conference call. My name is Lisa, and I will be your coordinator for today. At this time, all participants are in listen only mode. We will be facilitating a question and answer session towards the end of this conference. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Michael Fields, Chief Executive Officer. Please proceed, sir.

Thank you, operator. Good afternoon, everyone, and thank you very much for joining our call today. Our CFO, John Thompson, is out of the country, so joining me on today's call is Bill [Freitzman], our VP of Finance. Before I get started, I'd like to turn the call over to Bill who will give you the Safe Harbor provisions. Bill.

Thanks, Mike. 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. In addition, during our discussion today, we will be using GAAP and non-GAAP numbers. Our GAAP numbers and the reconciliation of our non-GAAP numbers to our GAAP numbers are contained in our Q4 and fiscal 2006 earnings press release that's available on KANA's Website at www.kana.com. Now, I will turn the call back over to Mike.

Thank you, Bill. When I spoke to you to announce our preliminary earnings on January 8, we had estimated revenues to be $14 million to $14.2 million for the fourth quarter. I'm pleased to say that our estimates were low. We came in at $14.9 million, an increase of 30% year-over-year. Fourth quarter license revenues were $6 million, an increase of 131% over fourth quarter of 2005. The fourth quarter of this year was the largest license revenue quarter that the Company has had since 2003.

We completed 2006 with total revenues of $54 million, an increase of 25% year-over-year. License revenues for the year totaled $19.1 million, an increase of 136% year-over-year. At the beginning of 2006, I laid out three key objectives for the Company, and at the end of each quarter I have updated you on those objectives. I'd like to give you a final report card on 2006 and lay out our key objectives for '07.

The first objective was to become the leading provider of enterprise multichannel customer service solutions. Second, was to develop and recruit the best people in the industry. And third was to lead the Company to operate with growing and sustainable revenue profit and cash. I'm pleased to report that we have made significant progress on all fronts, as evidenced by the Company's market position and financial performance.

With regard to becoming the leading provider of enterprise multichannel customer service solutions, KANA received the coveted leadership position in the 2006 Forrester Wave Report for e-Service. Additionally, we released major upgrades to our existing product suite in 2006, bringing new functionality to our customers. As a result, KANA earned a record number of product and innovation awards in 2006. Additionally, the Company held its first customer conference in five years, bringing together over 100 KANA customers from around the world. All of this was accomplished while leading an aggressive program of backshoring our engineering and technical support organizations.

In 2006, I laid out a strategy to bring back in-house our engineering and support teams in order to increase effectiveness, efficiencies and enhance innovations. I'm delighted to report that we have completed this effort, which I believe positions us well for 2007. We're off to a fast start with the January announcement of KANA 9.5, which is an integrated customer service suite available both in on-demand and on-premise implementations. KANA 9.5 offers companies industrial strength e-service capabilities with the freedom of choosing an on-demand or on-premise deployment.

Our second objective was to develop and recruit the best people in the industry. And as an example, we now have a strong sales leadership organization throughout the United States and Europe, including our new KANA European office in Dusseldorf, Germany. In 2006, we also established specific vertical sales teams to focus on the global financial services market and the Federal Government vertical. In 2007, we plan to extend that focus into vertical sales efforts to include global telecommunications.

Despite significant growth in our sales infrastructure, I'm very pleased to say that we still achieved record revenue per employee. Annual revenue per employee for 2006 was $298,000, based on year-end headcount. Our investment in KANA's sales organization is intended to capitalize on a tremendous opportunity in the customer service and support marketplace.

Industry analysts point to the continued increase in our growth opportunities for customer service and support. Gartner's most recently released figures project the market growing at a compound annual growth rate of 11.2%, a rate 25% higher than it was just in the previous year. We believe that we're well positioned in 2007 to take advantage of the strong underlying market dynamics.

Our third objective was to operate with growing and sustainable revenue, profit and cash. I'm pleased to report that 2006 was the first growth year for the Company with regard to revenue, profit and cash, since 2003. Additionally, I'm very pleased to report that we ended 2006 with a non-GAAP profit of $3.6 million, the first full year profit in the Company's history. In Q4, KANA closed 60 license transactions, the largest number reported in three years, with one license plus initial maintenance transactions that were over $1 million.

In particular, we experienced strong demand for the agent assisted and Web self-service solution KANA IQ, which accounted for 41% of the total orders for the quarter. We also experienced strong growth with our industrial leading e-mail management solution, KANA Response, which accounted for 45% of the total orders in Q4. New and existing customers that purchased KANA solutions in 2006 include AT&T/Cingular, British Sky Broadcasting, Federated Stores, HSBC, KLM, Priceline, Shurgard, TD Waterhouse, Verizon Wireless, and Xerox.

We continued to grow our alliance partnership with IBM. During the year, KANA exceeded its annual IBM quota by 183%, giving us the number one position within our alliance category. We continue to see substantial growth opportunities with IBM in our pipeline of opportunities in both North America and EMEA. I am very optimistic about the market opportunity, the pipeline, and the team we're building at KANA.

For 2007, our objectives remain, in large part, the same as '06. Our first priority is to continue to operate with growing and sustainable revenue profit and cash, which will maximize shareholder value. We will achieve these objectives by staying focused on being the industry leader in customer service and support technologies and continuing to attract and retain the best people in the industry.

As I told all KANA employees at our recent worldwide meeting, 2006 was the focus on business fundamentals and building the team. 2007 brings a renewed focus on innovation, execution, and growth. Now, I would like to turn it over to Bill to discuss our financials in more detail.

Thanks, Mike. First, a bit of housekeeping. As we outlined in our press release last week, we have reviewed the quarterly allocations of certain expense items within the year. Over the past week, we have been able to come to a final determination on these items, which led to us reallocate expenses between the four quarters of 2006.

Our full year 2006 results were unchanged. As a result, KANA was actually profitable on a GAAP basis in Q2 and Q3 of 2006, compared to what was previously reported. Upon adoption of FAS 123R in the beginning of 2006, we had incorrectly recorded expense for some historical options dating back to 1999, which resulted in the reversal of previously recognized stock compensation expense. We will disclose all of these details in our Form 10-K, which will be filed on or before its due date of April 2.

Moving on. As Mike indicated, fourth quarter revenues were $14.9 million, an increase of 14% over the third quarter of 2006. License revenues reached $6 million in Q4, an improvement of 36% over the prior quarter. Looking at our business geographically, the U.S. contributed approximately 2/3 of total revenue for both fourth quarter and for the full year. Given the significant increase in 2006 over 2005 revenues that we've had year-over-year, these percentages reflect a growing strength in both our domestic and our EMEA sales operations.

On today's call, I will be discussing our financial performance in both GAAP and non-GAAP measures. A reconciliation of our GAAP and non-GAAP financials can be found in today's press release.

Turning to the gross margins. Our overall gross margins were 76% in the fourth quarter, compared to 75% in the year-ago quarter, driven primarily by higher license revenue mix. In the fourth quarter of 2006, our license gross margins were 93%, compared to 71% in the year-ago quarter. This increase in license margins was primarily the result of reduced OEM royalty expenses.

Next, turning to operating expense lines. In the fourth quarter of 2006, sales and marketing expenses increased to $6.1 million, compared to $3.7 million in the fourth quarter of 2005. The increase in sales and marketing this quarter primarily reflected an increase in headcount, increased commissions due to higher sales, and increased marketing costs, including the cost of our worldwide user group meeting held in October. In the fourth quarter of 2006, R&D expenses were $3.2 million, compared to $2.7 million in the fourth quarter of 2005. The increase in R&D expenses from the year-ago quarter reflect increased employee expenses and contractor consulting costs.

In the fourth quarter of 2006, G&A expenses were $2 million, as compared to $3 million in the year-ago quarter. This decrease in G&A expense was primarily due to lower professional services and outside contractor costs in 2006, after we became current with our SEC filings, and an employee severance expense in the year-ago quarter. The Company recorded a fourth quarter 2006 non-GAAP net loss of $60,000. This is calculated by adjusting KANA's GAAP net loss of $1.4 million, by adding back the fourth quarter noncash accounting charges for stock-based compensation expense measured in accordance with FAS 123R and restructuring costs.

Given our new business activity and cost containment efforts, I am pleased to report that KANA had a 12-month non-GAAP net income of $3.6 million, calculated by adjusting the Company's GAAP net loss of $1.8 million, by adding back the noncash accounting charges for stock-based compensation expense, measured in accordance with FAS 123R, restructuring costs, the amortization of intangibles, the value of registration rights penalties, and the warrant liability expenses. This non-GAAP net income of $3.6 million in 2006 is a $15.1 million swing versus our non-GAAP net loss of $11.5 million in 2005.

On a GAAP basis, KANA reported a net loss of $1.4 million or $0.04 per share in the fourth quarter of 2006. For the full year ended December 31, 2006, the Company reported a GAAP net loss of $1.8 million, or $0.05 per share versus a GAAP net loss of $18 million, or $0.58 per share for the year ended December 31, 2005.

Turning to the balance sheet. Unrestricted cash increased to $5.7 million on December 31, 2006, an increase from $4.6 million at the end of the prior quarter. As a reminder, we paid off KANA's outstanding bank line of credit during July of last year. However, we have the full $8 million line of credit at our disposal should we need additional capital. 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 fourth quarter was 54 days, compared to 51 days for the prior quarter, and 58 days at the end June 30, 2006. At December 31, 2006, deferred revenue was $16.2 million, an increase from the $16.1 million reported for the prior quarter. As we have indicated in the past, deferred revenue was primarily comprised of maintenance and fluctuates based on the timing of maintenance renewals.

We ended 2006 with 181 employees, an increase of 28 from the ending headcount of 153 at September 30. This increase in headcount, in large part, has been focused on our sales organization, with additions to our quota carrying sales reps and to our sales management teams. We ended Q4 with 25 quota carrying sales reps, an increase from 20 reps at September 30. Now, I will turn the call back over to Mike.

Well, thank you, Bill. Lastly, I'd like to speak to guidance for 2007. KANA's business faces high growth opportunities and our market is very dynamic. That said, as has been the case over the past year, the exact timing of closing specific transactions can be difficult to predict. We believe that while our business model may contain fluctuations from quarter to quarter, if you extrapolate our prospects, our license opportunities, and the overall business opportunity over several quarters, our business carries tremendous growth potential.

Based on this backdrop, we anticipate that total revenues for fiscal 2007 will range between $62 million and $68 million, representing a growth of at least 15% to over 25% year-over-year. We feel that this is supported by the opportunities KANA enjoys, customer service and support market, and my confidence in our ability to innovate, execute, and grow throughout 2007. And we expect to be profitable on a non-GAAP basis for 2007 as well. With that, I'd like to turn it over to you for questions. Operator?

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Nathan Schneiderman with Roth Capital Partners. Please proceed.

Hi. Thanks so much. Congratulations, everyone, on a great year. Tremendous turnaround. You should be really pleased.

Thank you.

A handful of questions for you. I was hoping on the -- that you could give us the services decomposition, how much of the services revenue was maintenance, how much was professional service?

Well, it's -- I believe how we have defined services in the past, if I'm correct, Bill, is not to separate maintenance and professional services. Isn't that correct, Bill?

That's correct.

Okay. Can you -- you shared with us that you ended the quarter with 25 quota reps. Can you remind us what that number was in the year-ago period? And then also, how many people were there maybe in the sales management area? How many people are actually with quota, do you include the sales management, how did that compare with the year-ago period?

Sure. A year ago, we had 14 quota carrying individuals in the Company. Of the 14, three of them were in what would you characterize as sales and management positions, and 11 were in sales. Those sales positions included direct sales, or sales representatives operating in the field, as well as some inside sales representatives. In the 25 that we ended the year at, we also have significantly grown the sales management structure and we've done it, we think, the right way. We have done it very flat. So, we have first-line sales managers that own a number of sales reps who report to them and all of those individuals report to the person who runs our sales and service globally. At the end of the year, we had seven sales managers, plus the 25 sales reps. We have grown that now, I believe, to nine sales managers and 33 -- I'm sorry, we've grown it to nine managers and I think it's 31 or 32 sales reps to date.

Okay. So that total would be 40 and the year-ago number would be 14, including the management? 11 sales, three management?

Excuse me. The total is 38, and we have nine -- so it's 29 sales reps and nine sales managers, including the sales managers that handle all inside sales, as well as our renewal sales and the reps that handle inside sales and renewal sales as well.

Great. And that compares to 14 total --?

14 total a year ago.

Terrific. Could you give us -- and then just one more thing on the sales side. Can you share with us your sales hiring plans for '07? Is that going to be it, or do you plan to increase the sales --?

We believe that we see the market dynamics such that sales growth is going to be an important objective for us this year. We certainly do not see having to grow 100% our sales organization but we will grow additional sales representatives during the year as we continue to see the markets open.

Okay. Do you have specific target in mind?

Well, we've talked internally about some targets but it's certainly not going to be near 100% more over the year, more in the area of about 35% to 40%.

Compared to that 38 number?

Yes.

Okay. Great. Can you give us an update on the status of the Cigna contract and do you -- what's the visibility towards Rev Rec on that contract during 2007? Assuming that you have some visibility, is your feeling that it's going to be a first half of '07 or a second half of '07 event? And what, specifically, does it depend on?

I haven't forecasted into what half of the year or what quarter we believe the Cigna transaction will move from order status to revenue. We absolutely believe it will be in 2007 but when in 2007 is really something that we're working very close well IBM and Cigna on, based on their business requirements. It's an important transaction for us but it doesn't define us. We have significant opportunity that we're working on in conjunction with that transaction and we're very comfortable due to that with the guidance that we've given. So it's a great transaction for us and it will happen when the timing is right for the customer.

Does it have to follow the implementation of the Cordiant part of the deal or not necessarily?

There's a significant effort that's being undertaken in order to upgrade the call center activities that Cigna has and that includes technologies from other firms, as well as consulting work that IBM has to do. And our implementation follows that because once they have the call center operators with the latest technology, then, of course, they'll need to have the tools in order to give them integrated and consistent knowledge across the call center.

Can you give us an update on the relationship with IBM? You shared with us some details but I was curious if you could comment to the number of deals you've closed with IBM during Q4? And maybe a qualitative comment on how the pie -- the combined KANA/IBM pie looks now versus how it looked a quarter or so ago?

Well, it continues to grow but then so do the overall opportunity base grows. I've been in this business long enough to know, to try not to specifically determine when a particular transaction is going to happen never works. But I can tell you that our relationship with IBM has never been stronger. We now have, because of that strength, we have also added an additional alliance manager for IBM in Europe. And IBM had added, over 2006, additional alliance individuals who have quota responsibility for KANA in Europe.

So, we just see this relationship continuing to grow for reasons that are mutually beneficial to us and of course, beneficial to our mutual customers. So, they're an important part of our objectives in 2007. We expect that that relationship, particularly for the larger transactions, the $1 million plus transactions, will be a significant one, and represent a substantive part of our revenue in 2007. We have a lot of other transactions that we are working ,that are not only in the mid-size category but in the large category, that are outside of the IBM partnership. So to say when any of these are going to happen would be something I really couldn't do.

Okay. And then final question for you, just a few housekeeping type questions. I was hoping you could explain the sequential increase in the cost of services? And then also what was -- can you explain the restructuring charge? What was that all about and how does that impact things going forward? Thanks very much. And once again congratulations on a great year. Thanks very much.

Certainly the cost of service increase, a lot of that is as we're continuing to build appropriate talent and infrastructure in a service so that we can service the growing demand in our customer base for our professional services. But on the second half, on restructuring, Bill, maybe you can take that part?

Sure. Each quarter as part of our restructuring, we relook at the assumptions that underlie the accruals. And part of those assumptions were related to both -- I'll call it market dynamics of what the real-estate market in that particular area, as well as the sublease assumption. And in particular, there was a facility that was part of our restructuring on the East Coast that, when we relooked at the assumptions, we decided that we would not be getting sublease income, so we dealt with the expense that we recorded. On the other side, in California, we had a favorable adjustment because the market here has gotten better. So we were able to make a favorable adjustment, assuming that we were going to be able to sublease that facility and get market rates for it.

Okay. Any other questions?

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

Thanks very much, and I'll also add my congratulations for a great turnaround year for KANA. Mike, could you give us maybe just a little bit more color on what you think the KANA targeted of mix revenue is that you're thinking about for 2007 in terms of the breakdown between licenses and services? And how should we be thinking about the margins on those revenues as well?

Well, as we look in 2007, we believe we'll continue to see very strong growth on the license side at percentages that are significantly higher than on the services side, for obvious reasons. And we believe that we'll start seeing the strength that we saw in Q4 in what I call the mid-tier transaction size, we kind of define it as those transactions that are below $100,000, than those that are between that $200,000 to $800,000 and those that are over $1 million. And we saw some great growth in that $200,000 to $800,000. And typically what that means is that we have a lot of clients who are making initial implementations of our products, that then will lead to a larger transaction in the future. Or it's a cross-sell/up-sell into our existing base where they have made a large transaction and now they're getting some additional capabilities that they're adding to it.

And that represents that kind of transaction size that you should expect your sales force is doing consistently. And as we start seeing the effectiveness grow in our sales organization, we expect to see that consistency happen as that base transaction base. So if you look at Q4 where we had one transaction over $1 million and -- but we still had a largest license revenue year ever -- not ever, excuse me, in the fourth quarter, that it shows that we're starting now to see the turn that we wanted, and that is, our sales force getting those mid-tier transactions, making them stronger, making our relationships with our customers stronger and leading to larger transactions that take place in future quarters.

Would it be fair to say that, as you look at the pipeline heading into 2007, that those $200,000 to $800,000 transactions are a significant component of the pipeline?

It represents certainly in terms of numbers of transactions, a significant component versus the larger ones. In terms of value, it's about even between the two but we have some fairly large $1 million dollar plus transactions that we're involved with in the marketplace today. So that, of course, it's great but it also means it has a substantive value in that part of the pipe.

But with the new sales reps that have come in, and as you can tell, we have a lot of new sales reps who have joined the Company, it's a great place for them to go, because we can go into our large customer base, we have $600,000-plus clients, and talk to them about cross-sell/up-sell opportunities within that account. What happens then is that they gain significant knowledge about the value proposition, the business proposition of the implementation of our products. And then that carries over as they are talking to prospective clients about -- who may not have our technology, about what value to expect. So, it's a win-win for everybody. Customers get what they need and our sales force gets stronger and smarter about the true business value in implementing KANA solutions.

Great. Any changes to the competitive landscape? I know some of your competitors have publicly said that they are going to stop selling perpetual licenses in favor of the on-demand model. Maybe you could just give us some high-level commentary on what kind of competition you're seeing out there and where do you think your on-demand model fits within that strategy?

Well, there's one thing that we believe very strongly and this comes from talking to our customers in the marketplace, that on-demand is a deployment methodology. It's not a product. On-demand doesn't define the scope of product functionality that you offer to a customer in order to enhance their ability to deliver exceptional customer service. It does offer a significant way for rapid deployment. It offers a great way for customers to reduce their operating costs relevant to supporting their customers.

But we're finding that customers want to be able to make a choice based on their particular business model and sometimes that choice may change. So our strategy is to offer the choice to our customers between on-demand and on-premise. Our on-demand solution that we have just brought to market, our complete solution, is one code base for on-demand or on-premise. But even more importantly than that, it it's the most highly functional, highly scalable feature-rich product line, we believe, in the marketplace.

And at the core, that's what customers usually want to start with. Are you going to solve my business problem? And now let's talk, if you can. Then let's talk about how we deploy it in order to ensure appropriate costs and security and compliance and other areas of doing business. So you will find that KANA will continue to support the notion that the decision between on-demand and on-premise should be a customer's decision and not a vendor's decision. Great. Thanks very much.

There are no additional questions at this time. I will now like to turn the presentation back over to Mr. Michael Fields for final remarks.

I would like to thank everybody for listening in today. We are excited about 2007 and beyond. We -- our team had a very good year in 2006 and we would love to see that grow in the coming years. We're continuing our focus on being the leading provider in multichannel customer support solutions and customer service solutions. You will see us grow our capabilities in those areas over the year and meet our financial objectives to our Investors. So thank you, again, for listening in, and we'll look forward to talking to you at the end of Q1.

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