SWK Holdings Corp (SWKH) 2007 Q1 法說會逐字稿

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Good day, ladies and gentlemen, and welcome to the first quarter 2007 KANA Software earnings conference call. My name is Katina, and I will be your coordinator for today. At this time, all participants are in a 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.

I would now like to turn the presentation over to your host for today's call, Mr. Michael Fields, Chief Executive Officer. Please proceed.

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

Before we get started, I would like to turn the call over to John Thompson, our CFO, who will give you the Safe Harbor provisions, John?

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 our customers and integrators, anticipated benefits from our acquisition of eVergance, our long-term success, new hires, our product and product development efforts and characteristics of our market segments.

These forward-looking statements are subject to material risks and uncertainties described in our most recent filings with the SEC, including recent reports on Form 10-Q and Form 10-K, and no one should assume that the comments we provide today will still be valid later in the quarter, and we will undertake no obligations to update these statements as a result of future events.

Also, I want to mention that KANA excludes certain certain non-cash items, such as FAS 123R stock option compensation expenses for the purposes of internal recording, reporting, excuse me. We believe that these non-GAAP numbers provide a more accurate and meaningful basis for analyzing the Company's current and historic performance. I exclude these noncash compensation expenses from the following discussions. A reconciliation of our GAAP and non-GAAP financials appears in today's press release.

Now, I will turn the call back over to Mike.

Thanks again for everybody joining us today. Before we begin with the numbers for Q1, I would like to make a few comments about 2006 and why I believe that during the past year, we established a foundation for the future. Simply put, we proved to the world that we are back in business. 2006 was the first growth year for the Company with regards to revenue, profit and cash since 2003. During the year, we grew total revenue by 25%, and licensed revenue by 136%.

While we focused on the financial turnaround, we continued to invest in our market-leading multi-channel customer service support products, and during the year, we received 11 industry awards, including the coveted Leadership Position in the 2006 Forrester Wave report for eService.

During 2006, we also continued to grow our relationship with IBM, by achieving 183% of our IBM quota. This led us to achieve the #1 position within IBM's Tier-2 alliance category.

Finally, we recruited and retained what I believe to be a world-class team. We promoted experienced talent within the Company, and gave them responsibility and authority and the accountability to lead. We also brought in new talent from the outside, including those who increased our sales force from 16 reps and first line managers to 33 by the end of the year.

In summary, I am pleased that we executed on establishing the goals and objectives of last year, and we look forward to build upon this foundation in 2007 and '08. I will discuss our plans later in the call, but first, let me pass the call over to John, for a review of our first quarter financials. John?

Thanks again, Mike. Looking at new orders for new license and initial maintenance, what we call WIM, KANA closed 40 transactions in the first quarter ended March 31st, 2007, including one transaction over $1 million versus 37 deals in the year-ago quarter, when we did not have any transactions over $1 million.

Excluding the follow-on additional seat deals, the average selling price for new license and initial maintenance, what we call WIM, as well as OnDemand and hosted new orders over $100,000, was $349,000 compared to $233,000 in the year-ago quarter. Our On Demand offering was formerly launched interquarter on January 22nd, and provides our customers the opportunity to implement the single code base of KANA's products in either On Demand or On Premise deployments.

During the six weeks or so the On Demand option was available, we signed five On Demand customers. Overall, we gained 8 new customers this quarter versus four in the first quarter last year. Looking at our business geographically, the United States contributed approximately 60% total WIM and On Demand order dollar volume in the first quarter, somewhat higher than the 50% in the prior quarter.

Turning to the income statement for the first quarter ended March 31st, 2007, KANA's revenue was 13 million, an increase of 14% over the year-ago quarter. License revenue was 3.6 million, an increase of 26% over the year-ago quarter. Services revenue was 9.4 million, an increase of 10% over the year-ago quarter. On Demand revenue was included on the Services revenue line. As a reminder, the following comments describe non-GAAP performance.

Our overall gross margins were 75% in the first quarter relatively consistent with the year ago quarter and prior quarter. In the first quarter of 2007, our license gross margins were 92% compared to 84% in the year-ago quarter. This is due to the mix of software products sold and the leverage we gain with the higher license revenues, and relatively lower OEM royalty expenses, due to some fixed fee OEM royalty costs.

In terms of our first quarter ended March 31st, 2007, operating expense lines, sales and marketing expenses were 6 million compared to the prior quarter 6.1 million. R&D expenses increased to 3.6 million from 3.2 million in the same quarters, primarily due to employee-related expenses. G&A expenses also increased to 3.1 million from 2.6 million as a result of our auditor's work on our 2006 audit which was performed and expensed during the quarter, and legal fees related to the settlement of a past lawsuit. The Company recorded a first quarter 2007 non-GAAP net loss of 3.0 million, or $0.08 loss per share.

In general, non-GAAP operating expenses should be expected to increase with added headcount, and with higher sales commissions and bonuses during the remaining quarters of 2007. As a reminder, KANA carries substantial net operating loss carry-forwards.

In January 2006, we adopted a shareholder rights plan in order to preserve these NOLs for tax purposes, because the Company believes that its NOLs constitute a substantial asset. Any investor is currently limited to ownership of no more than 4.9%, except our investors who already have more than a 5% ownership. The rights plan limits our two larger investors to an increase of no more than 1% additional ownership.

Turning to the balance sheet, unrestricted cash was 5.3 million at March 31, 2007, and includes $2 million of borrowings from our existing line of credit. Day sales outstanding for the first quarter ended March 31st, 2007 was 54 days, the same as for the prior quarter, and compared to the 49 days at the end of March 31st, 2006. At March 31st, 2007, deferred revenue was 15.8 million, a decrease from the 16.2 million reported for the prior quarter. As we have indicated in the past, deferred revenue is primarily comprised of maintenance, and fluctuates based on the timing of maintenance renewals.

Moving on to head count, at March 31st, 2007, the Company had 194 full-time employees, an increase of 13 from the 181 employees we had at the end of the prior quarter. Included in these March 31st numbers are 30 quota-carrying sales reps, an increase of 5 from the 25 quota-carrying reps at December 31st, 2006. In terms of our overall sales infrastructure, which includes sales managers and quota carrying reps, we ended this March with 39 people, almost double the 21 managers and reps in the sales organizations at the end of the quarter ended March 31st, 2006.

Before I turn the call back over to Mike, I would like to address our capital structure. Given the announcement of our acquisition of eVergance earlier today, along with the capital requirements associated with our growth plans, we believe it is prudent for us to proactively evaluate a variety of financing alternatives, which will provide us with not only near term liquidity but also preserve our NOLs and minimize the dilution of our existing shareholders.

Back to you, Mike.

Thank you, John. Now I would like to turn to our 2007 strategy. As we look to continue our turnaround efforts in 2007, I have set aggressive expectations for the new team that I have assembled at KANA. If I have learned anything about my many years in the software industry, experienced as it is, a solid strategy matched with a capable team and an award-winning product are the ingredients to produce real value to the market. My plan for KANA follows a very methodical approach.

I believe that 2007 is a year that we build a foundation for growth, upon the success of 2006, leading to future accelerated growth. Turnarounds don't happen overnight. But with a methodical plan and the right team in place, I believe that we are creating a recipe for success. For 2007, our focus is on five key foundations for growth.

First, build a strong foundation for growth within our License business. We continue to focus on our 600 customer installed base for cross-sale upsell opportunities, and believe that tripling our quota carrying sales rep team worldwide, to focus within this space and lead to substantial organic license growth for the Company. We are also implementing a focused approach to new business and targeted verticals, such as Financial Services and the Federal government. We initiated some very creative marketing programs with IBM, for example, their mystery shopper program, to drive new license opportunities with both existing and new accounts.

Our second foundation for growth initiative is our On Demand strategy. In January of this year, we launched KANA On Demand to meet the needs of customers and prospects, who wish to deploy robust customer service solutions in a software as a service model. We are very pleased with the interest level we are seeing with this new delivery model, in both the enterprise and the midmarket segment. In order to capitalize on this opportunity, we built an inside sales organization who focuses on midmarket and departmental opportunities.

The third foundation for growth is within our service organization. We embarked on enhancing our service groups with today's announcement of our entry into a definitive agreement to acquire eVergance Partners, a provider of end-to-end strategic consultant services for knowledge management, web self-service, and business intelligence.

It is anticipated that this acquisition will double the size of KANA's professional services team, and expand our Company's professional services offers into all areas, including deployment support, customer service strategy, optimization and managed services. eVergance will provide a new set of offerings for KANA customers to complement and extend the services currently provided by KANA and its partners. We believe KANA customers will be able to take advantage of eVergance deep domain expertise and customer service technologies, and Best Practices. The financial terms for this will be disclosed upon closing this transaction, but for now, I can tell you this acquisition is expected to be accretive within 2007.

The fourth foundation for growth is our investment in people. I believe that at the core of any successful organization, leadership focuses on establishing a strong culture, a set of core values that become the guiding principles, and a foundation for an organization. In assessing our investments into people, process and technology, we determined that a key area we needed to enhance from a leadership perspective was in the corporate development strategy.

On Friday last week, we are very pleased that we announced that industry leader Mark Angel has joined KANA's executive team as Senior Vice President of Corporate Development and Strategy. Mark will lead the team in driving the core framework for which we will invest in technology and innovation and go to market strategies. Mark is very well known in the customer service industry for his passion, and for his vision for customer service innovation. We are very excited that Mark made the decision to join the KANA team.

And finally, our fifth foundation for growth initiatives is to continue our leadership position in technology and innovation. We will continue to certify our industry standards, such as service oriented architecture, knowledge-centered support, along with our commitment to a portal strategy supporting the IBM architecture.

In regards to our award-winning customer service applications, we have continued to deepen our integration process through our channels, and now we are providing increased support, for example, with our new proactive check capabilities recently announced, as well as new functionality in our outbound e-mail solutions. There has never been a more exciting time in the customer services industry.

Companies are recognizing the strategic value of their customers and realize that customer service of the future will require innovative technologies, to maintain customer retention and loyalty. In 2007, you will see the Company deliver the next generation of customer service solutions that are more intelligent, more proactive, and more pervasive. Our product plans call for industry-leading product releases in the fall of this year, that will distance us from the competition while focusing on a larger share of the customer service end-to-end solution market.

Now turning to guidance, we, as I have indicated in past conference calls, KANA's business faces high growth opportunities, and we believe our market is very dynamic. That said, as we have seen during 2006, 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 exploit our prospects, our license opportunities, and the overall business opportunities over several quarters, our business carries tremendous growth potential. Our pipeline has never been bigger and reinforces our confidence in the full-year revenue outlook.

Also note that today's guidance is based on KANA as a standalone entity and excludes the impact of the acquisition of eVergance announced earlier today. We will include eVergance in our guidance in our Q2 investor call, when we address, when we next address guidance.

With this in mind, our revenue outlook remains intact, and we are maintaining our full-year guidance for total revenues of 62 million to 68 million, representing growth of at least 15 to 25% year-over-year. We feel that this is supported by the opportunities KANA enjoys within the customer service and support markets. And I am confident in our ability to innovate, execute, and grow throughout 2007.

Before I turn the call to questions, I would like to remind everyone that KANA will be holding an Analyst Day on Thursday, May 24th, in New York City. The Analyst Day will provide you with an excellent opportunity to meet many members of the KANA senior management team, as well as hear from some of our customers. We look forward to seeing many of you there.

And operator, I would now like to turn the call over for questions.

Thank you, and thank you for that presentation. Ladies and gentlemen, (OPERATOR INSTRUCTIONS) Questions will be taken in the order received. Your first question will come from the line of Nathan Schneiderman, representing Roth Capital Partners. Please proceed.

Hi. Thank you very much. Hi Mike, hi John.

Hi.

Handful of questions for you. First, I was hoping that you could comment on license revenue for the quarter. What was your feeling about the license revenue in general, were you happy with it? Did it come up short? And were there any dynamics such as deals that may have flipped toward routable late in the quarter deals that pushed, that were kind of outside your expectations?

Well, the license revenue number we achieved was within our expectations within the context of us getting to our 62 to 68 million. We did not have any convergence or conversion, if you will, from License opportunities to the On Demand model. Our On Demand wins were in fact On Demand opportunities that we won.

We still have a continued strength in our maintenance and renewal business, where we didn't have any conversions there, either. You know, you always want more license revenue. I certainly won't doubt that. But we are still very comfortable and confident about our strategy for the year.

Okay. And then on the expense side, G&A quite a bit up sequentially, and you mentioned that there were some legal fees. I was just curious if you could break out for us expenses that you feel were more one-time in nature. And what those expenses were, and then also, R&D seemed to be up a good bit sequentially as well. Were there any special one-time issues there? Or is that just the natural rate going forward?

Well, I'm going to let John answer the specifics about it. But I just want to say overall, that, we are in that place where we have made substantial investments on our distribution organization and our ability to support our customers. And when you grow a sales force as we have, you have that path to normal sales force productivity. Most of our sales reps have only been here over about the last six months. And they are doing a great job in building our pipeline, and taking our technology to market.

We have also made a number of changes in our support structure, as you know. That puts us in a position of really being able to expand and grow within our support organization. So some of those costs, some of them continue. But they all represent higher costs in the early months and quarters of this turnaround that we are doing. But we did have some very specific things that were substantive cost in the quarter that John will address.

In the area of G&A, Nate, the audit was one certainly, when you have to basically take all of your annual audit fees in one quarter, that is a fair amount of money. We had legal fees associated with both both Polaris settlement that we've had, the patent lawsuit that was against us that we have announced already. And then there is another lawsuit from our friends up in Bozeman, that had some fees associated with it. We had a face to face worldwide employees meeting, where we flew the entire company in for a couple days' worth of meetings. That added some expense to Q1.

In all the functional areas, we get hit with the additional payroll taxes that start up again for everybody. In the R&D area, that you also asked about, there were some R&D people who got some bonuses that quarter for the outstanding work that they had been doing. Now, that certainly wasn't the whole difference, but that was part of it. And the rest was just generally related R&D functions and contractors and things that were there.

Okay. Maybe asking the question a little bit differently, what kind of sequential decline in G&A are you expecting in Q2, because you won't have some of these added fees?

Well, the decline is offset in part by the increase in the SOX costs. The Sarbanes-Oxley costs. There should be some decline in G&A, but it will be offset by the startup of our more, of the heavier part of our Sarbanes-Oxley expenses.

Okay. So, this is, we should look at the G&A and R&D level as kind of the natural level going forward, and not unusually step function high this quarter?

G&A is probably maybe, maybe a little bit high. R&D, probably not. It should be flat or up.

Okay, got it. Of the 9.4, how much was maintenance and how much was pro serve?

We don't provide that information, we haven't historically.

You have typically provided it in your Annual?

Yes. You're not able to provide --

Right. Are you able to provide that component that's OnDemand?

No, we haven't provided that one, either.

In the past, you have given us the number of deals exceeding $100,000.

I am trying to remember how many there were. 45 total transactions. I don't have that number off the top of my head, Nate.

Okay. Mike, I was hoping you could talk in a little more detail about the eVergance acquisition. What are you hoping to achieve with that acquisition? And how do you see it affecting the types of services you can offer your customers in the future? And what do you see as the margin implications, and the operating profit implications of the deal?

You know, I really think that this is a perfect time for to us do something like this, as we are in this growth mode, and focused on, you know, deploying the right team to go to market. Our, we are looking to the future for substantially growing operating margins. So now is the right time to bring something into the Company, that may not represent product operating margin as we are getting our product line turned around.

eVergance is going to be a great opportunity for us. And even our partners, when you think about our relationship with IBM, we are consistent and have been consistently asked for IBM to have more strategic services personnel, who can help answer the questions about integrating these kinds of solutions within the overall deployment of a business process, or engineering activity that IBM is doing.

And now we will have that talent available. But as you know, IBM primarily deals with the very large corporations, and I believe and I have seen is that your high-end midmarket and some of your other enterprise companies in the Fortune Global 2000, also have the need for these kind of services when they look at customer service transformation.

So eVergance now, through their capabilities, will allow us to participate in those kinds of strategic services options, which sometimes take place a year before the customer actually makes a decision to buy a product. So you know, they have some terrific expertise within the organization. It will allow them to grow that expertise faster. You know, they are going to a very much larger sales force, who will be able to sell their services on a global basis, within the context of selling the KANA product line. So you know, everything we see about this is going to be great for our customers, great for our partners, and really great for KANA as we move through 2007 and '08.

Given that eVergance focuses on higher-end situations, is it safe to say that the gross margin of pro services, there should be a catalyst for significant improvements, or not so much?

Well, it is really tough to predict that right now. I would say strategically, we would expect that. We would expect that particularly, of course we have the timeframe of getting this all integrated. But strategically, we would expect that. You know, we have a very strong consulting organization now.

That primarily focuses on what we would characterize as installation, configuration and deployment, and we do a great job of that. Our organization that we have now is also involved in some strategic implementations for our customers. The major value that eVergance brings is our ability to impact strategic services before a transaction. And our ability to do much larger long-term services for customers that are looking at business product transformation. And you are right, those service rates are much higher than your traditional ICD rates.

Okay. And final question for you and I will drop off. You made a quick reference to looking at some financing alternatives. Any chance you can get more granular there, and let us know some of the things you are thinking about? Thanks very much.

Nate, before you go, I did check and we had 13 transactions over $100,000.

Okay, thank you.

With regard to capital structure, as John pointed out, we are looking at capital formation for a number of reasons. Now, at the core, we believe, we #1, you know, want to enhance the liquidity position of the Company. We think that we have put in place the right kind of discipline now relevant to managing cash. But at the core, we know that our optics could look better. At the core, we want to do something that will most certainly preserve our NOLs. That is very important to our Board, and our investors as well.

And we also want to insure we do something that doesn't create significant dilution for our shareholders. So we are looking at what the right sizing might be, maintaining that expectation. And putting us in the position to take a look in the future at other opportunities and options that might present itself in the marketplace. We haven't, you know, officially sized this yet. But we think over the coming weeks, we will be able to say more about it.

Okay. Thank you very much. Good luck.

Thank you.

Thanks.

Any other questions?

Your next question will come from the line of Ed Hemmelgarn representing Shaker Investments. Please proceed.

Could you just talk a little bit more about the license revenue? I guess given the growth in your sales force over of the last three quarters, you know, and given where it was at last year in the first quarter, the number of, I am a little surprised that you didn't have more deals. And that the license number wasn't higher. You indicated you are pretty happy with the sales force. But given that you have got, your desire is to have a fairly significant deal per quota-carrying sales rep, this leaves a lot to go throughout the rest of the year.

First of all, we have deployed significantly greater quotas than the license revenue that we expect to or we planned for, for the year. I would suggest to you, though, that our sales reps are really new. I know when you just look at the numbers, you might think well, we just doubled in size. But the reality is, and I mentioned that we had 16 at the beginning of '06. By the middle of '06, only 6 of those 16 were left. We made not only a transition in adding sales reps but also turning over and bringing in, we think, a much higher quality rep.

And they are going through that transition of learning there territories, learning their customers, learning their competitive sales strategy. Our pipelines right now are the best pipelines I have seen since I have been here. And I think we have pound for pound a very good sales force. You know, the results will continue to grow during the year. And this is one of the major reasons why.

When I gave guidance at the beginning of the year, I gave guidance for the year and not for the quarter I knew we were in this process, and I stated it. We were in this process of turning the Company around. There are many aspects of this that are moving and it is all moving in the right direction.

But given the fact that the vast majority of the sales reps that we have on board today haven't been here six months, you know, we have a lot of growth potential this year as they continue to come on board. Understand the market, understand the technology, and understand how to win competitively.

You know, you said the vast majority of sales reps haven't been there six months? I guess I was thinking, what was the number you had at the end of September of last year? Of sales reps or something. It just, it strikes me that you seem to be making pretty good progress and certainly the fourth quarter looked very promising, especially in the insignificant increase in the number of smaller deals.

But I had expected less of a falloff from Q4, given that you would think is that the sales force, since you have just, you have added so many new people throughout '06, that you would be making, that the progress would be in a growing manner. And I realize that there tends to be a falloff from Q4 to Q1. But given that this is a fairly new sales force that you have now, at the beginning of the year, you had certainly more sales people than you had, for example, at the beginning of the fourth quarter. And more people with more than 3 months' experience.

Well, what I can say is that our pipeline has grown substantively. It takes time for sales reps to ramp and get into the proper flow. They have to, as I mentioned, understand the customers and the value props, how to present it. We have a very wide range of products, and these guys are ramping up very quickly. But they are relatively new, you know. We have been very fortunate. We have gotten some very experienced individuals in the organization. But I got to tell you, I am happy with the progress they have made so far.

Okay. Ladies and gentlemen, (OPERATOR INSTRUCTIONS) There are no further questions at this time. I would now like to turn the presentation back to Michael Fields for closing remarks.

I would like to thank you, operator. I would like to thank everyone for joining us on the call today. We remain very excited about the future of the business. We are diligently at work adding value for our stakeholders, and I look forward to talking to you again soon, particularly with the closing of the eVergance transaction, and of course, next quarter. So, thank you very much.

Thank you for your participation in today's conference. This concludes your presentation. You may disconnect. Have a good day!