SWK Holdings Corp (SWKH) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to KANA Software's second quarter results conference call. My name is Grace Ann, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (OPERATOR INSRTUCTIONS) 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 conference, Mr. Michael Fields, CEO of KANA Software. Please proceed.

Good afternoon, everyone, and thank you for joining us on the call today. Before we get started, I'd like to turn the call over to John Thompson, who will give you our 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 customers and integrators, restructuring, anticipated benefits from our acquisition of eVergance, our long-term success, new hires, employee head count, 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. No one should assume that the comments we make today will still be valid later in the quarter and we will undertake no obligation to update these statements as a result of future events. I'll turn the call back to Mike.

Thanks again everyone for joining us today. If I've learned anything in my many years in the software industry, it's that turnarounds don't happen overnight. With a methodical plan, the right leadership team and technology that meets real needs in the marketplace, we can create a recipe for success. I'm confident that at KANA we have these elements in place and are now fine tuning them to build a foundation for growth. To summarize our results for Q2, total revenues showed sequential improvement over the prior quarter without, I might add, the benefit of closing any seven figure transactions. Total revenue for the second quarter was 13.4 million, up from 13 million in the previous quarter. KANA closed 51 license and OnDemand orders in the second quarter of 2007, up from 45 transactions in the year-ago quarter. The Company continues to execute well on its strategy of cultivating, cross sell and add-on opportunities within our install base. Last year, I embarked on a strategy to lessen our dependency on larger seven-figure transactions. Our performance this quarter exhibited substantial improvement here, having increased revenue sequentially without a large transaction. Importantly, we saw improved transaction flow in our sweet spot, having closed an increased number of medium-sized deals, That's license or OnDemand transactions ranging between 100,000 and 800,000. During Q2, we closed 14 such transactions in this sweet spot versus eight in the year-ago quarter. It's important to note though that while we reduced our dependency on large seven-figure transactions, the opportunity pipeline in both seven-figure transactions and six-figure transactions has expanded significantly in Q2.

Customers that purchase KANA solutions during the second quarter include Cingular wireless, Delta Airlines, Icelandia Air, ING Post Bank, IFDS, Telenet, M to M -- MMO2, excuse me, TD, Ameritrade, Tiffany and Company and Time-Warner Cable as well as many others. Our leadership continues to be noticed by the customer service market. During Q2, KANA was recognized as a leader by Forrester Research and the Forrester Wave report on customer service management. KANA outranked all other vendors for current offerings which included product architecture, platform, product usability, customer service, internationalization, business process support and cost of ownership. It is the exactly this combination of technology leadership, service excellence and customer value that continues to make KANA solutions a compelling choice for many buyers. KANA was also named a service leader in the web support services category by CRM magazine with the highest score for reputation for customer service. And was recognized in the 2007 CRM excellence award for customer interaction solutions magazine.

We continue to be encouraged by the large market opportunities KANA faces. Based on the recent 2007 global contact center benchmark study, over half of contact participating contact centers identified developing multi-channel capabilities as a top priority. Importantly, the study also highlighted how self-service technologies, e-mail management and SMS are seen as continued investments and focus. We believe that we are very well positioned for continued growth and execution within the multi-channel market. As we look to the second half of 2007, we are not standing still. We will continue to fine tune our efforts and become laser focused within our sales and service organization. We are striving to show greater efficiency and effectiveness from our sales and service teams. As a direct result, our number one service meet, of course, our quarterly license and our revenue projections.

Next, let me discuss some recent developments. First, with sales, over the past 12 months, we've aggressively expanded the worldwide sales organization to capitalize on the market potential at hand. At the end of Q2, we recognize that we had not achieved expected revenue targets and needed to refine our approach. As we discussed on July 6th, we made adjustments to our sales strategy and sales leadership team to position the Company to meet second half and overall 2007 objectives. Our number one sales initiative is to maximize our ability to win business early and often. This starts with focusing our field sales team on large named enterprise accounts to provide a title link with our customers. Field sales representatives are more closely focused now on specifically named accounts within geographical territories. Our inside sales team has proved itself to be very effective. This inside team will focus worldwide on mid-market opportunities and those accounts that are not in the named account target list. KANA's renewal maintenance team will continue to focus on customer renewals worldwide as well as selling select professional services packages to customers that want to transition to the latest releases. To oversee our overall sales effort, we've also recently promoted Danny Turano to Senior Vice President of Worldwide Field Operations. Previously, Danny was responsible for our world worldwide financial services vertical. Danny has held leadership roles in technology companies for over 25 years with a track record of success in pioneering, CRM software companies such as Oracle, Siebel, and Scopus. Currently, we have 27 quote acquiring reps. Approximately 19 of these 27 reps have been with the Company for over six months. As a result, we feel very confident about the cohesive team that we have in place, these reps know our products and technology and have experienced closing large transactions. We are also looking to hire in certain geographies during the second half of the year.

Our global strategic partnership with IBM continues to be extremely strong. We continue to drive substantial business through the IBM relationship and have been partnering with IBM on joint marketing and business development opportunities throughout the U.S. and EMEA to drive incremental pipeline. One example is the recent KANA - IBM study of 72 of the largest financial services institutions in North America. This report examined these companies on-line service capabilities which has created a significant number of opportunities in some of the largest U.S. financial services companies.

Moving to services, in achieving our financial goals, we expect significant revenue and margin contribution from our professional services as well as our sales organization. Together, the eVergance and KANA teams will provide end-to-end professional service solutions including strategic, transformational, implementation and integration, training and managed services. Its collection of services will be unique in our industry and unparalleled by any of our competitors. Finally, during the quarter, Sham Chotai joined KANA as Senior Vice President of Engineering. in this role, Sham will oversee the product management, product development documentation and quality assurance of all KANA products. Working closely with KANA's CTO, Charlie Isaacs, to continue to deliver innovative market leading customer service solutions. As I laid out for you in our last earnings conference call, my plan for KANA remains, 2007 is a year that we will build upon the foundation. 2008 is the year of accelerated growth. This turnaround has not happened overnight but with the methodical plan we've put in place, the team that we continue to develop, we believe that we're creating the right recipe for success. Now, I'd like to turn it over to John to discuss our first quarter financials in more detail. John?

Thanks, Mike. Excluding the follow-on additional seat deals, the average selling price for new license and initial [INAUDIBLE] we call WIM, as well as OnDemand and hosted new orders over $100,000 in the second quarter ended June 30, 2007, was $273,000 compared to $781,000 in the year-ago quarter. As a reminder, there were two billion dollar plus license transactions in the year-ago quarter. Looking at our business geographically, the U.S. contributed approximately 70% of total WIM and OnDemand order dollar amount in the second quarter. We're pleased at efforts at reducing our dependence on large transactions are continuing to show improvement. For Q3, license revenue came in at $3.5 million, down just $100,000 from the prior quarter without the benefit of a seven-figure transaction. KANA did have one large seven-figure license transaction in Q1 of this year. Meanwhile, Q2 total revenue, maintenance revenue, professional services and OnDemand revenue all showed sequential growth over Q1.

Turning to the income statement for the second quarter ended June 30, 2007, KANA's total revenue was 13.4 million, licensed revenue was 3.5 million, services revenue was 9.9 million. KANA excludes certain non-cash items such as FAS 123-R stock option compensation expenses for the purposes of internal recording. We believe these non-GAAP numbers provide a more accurate and meaningful basis for analyzing the Company's current and historic performance. I will exclude these non-cash compensation expenses from the following discussion. A reconciliation of our GAAP and non-GAAP financial numbers appears in today's press release. Our overall gross margins were 71% in the second quarter ended June 30th. In terms of our second quarter ended June 30, 2007 operating expense lines, sales and marketing expenses were 6.4 million, R&D expenses were 3 million and G&A expenses were 2.8 million. The Company recorded a second quarter 2007 non-GAAP net loss of 2.9 million or $0.08 loss per share. In general, non-GAAP operating expense should be expected to decrease from the second quarter with lower contractor expense offset with some additional hiring and higher sales commissions and bonuses during the remaining quarters of 2007. As we outlined in our July 6th call, we implemented measures to reduce costs, drive growth and improve our overall business performance. These measures are expected to yield annualized cost savings of $6 million a year with a partial benefit being realized in Q3 due to the time it takes and the penalty cost to terminate some contractors as well as the termination timing and severance payments to employees. As a result, we expect one-time costs of approximately 1.1 million in Q3. The full benefit of our implemented measures should be realized in Q4. 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 the 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 limited are to existing greater than 5% shareholders for a maximum increase of 1% additional ownership.

Turning to the balance sheet, unrestricted cash, which was 4.5 million at June 30, 2007, and includes 4.7 million of borrowings from our existing line of credit. Note that accounts receivable increased by over $2 million over the prior quarter because of high maintenance renewal invoices in the latter part of Q2. Day sales outstanding for the second quarter ended June 30, 2007, was 67 days, up 13 days from the prior quarter and compares to 58 days at the end of June 30, 2006. Of the 13 day increase, four days comes from including eVergance and nine days come from the timing of and the amount of maintenance renewals. At June 30, 2007, deferred revenue was 18.1 million, an increase of $2.3 million from the amount recorded for the prior quarter. As we have indicated in the past, deferred revenue is primarily comprised of maintenance and this increase is due to higher maintenance renewals in Q2. Moving to head count, as of today, the company has 236 full-time employees, an increase of 42 from the 194 employees we had at the end of the prior quarter. 30 of this increased head count are due to the acquisition of eVergance. Now, I'll turn the call back over to Mike.

Thank you, John. Turning to guidance, I have confidence in KANA, our products are -- the value of our installed customer base, our opportunities and our organization. As outlined in our July call, the number of large transactions, those above a million dollars in our pipeline, grew year-over-year. KANA's business faces high growth opportunity and our market is very dynamic. That said, we have now seen during the first half of the year, the exact timing of closing specific transactions can be difficult to predict. We continue to believe that while our business model may contain fluctuations from quarter to quarter, if you manage our prospects and our license opportunities in the overall business opportunities over several quarters, our business carries tremendous growth potential. In fact, as of today, we feel great about our prospects for the second half of the year since during the month of July, we've already closed a major seven-figure transaction with the U.S. Post Office, replacing an OnDemand competitor with our Premise-based solution. For the second half of 2007, we're updating our guidance for a total revenue to be 60 million to 64 million, representing an annual growth of at least 10%. We remain committed to reach operational profitability for the full year. We feel that this is supported by the opportunities KANA enjoys with our customer service, our support marketing and our confidence in our ability to innovate, execute and grow through the remainder of 2007. So now, operator, I'd like to turn the call over for questions.

Thank you. (OPERATOR INSTRUCTIONS) Your first question comes from the line of Nathan Schneiderman of KANA Software.

Hi, this is Nick Pajwani for Nathan. Thanks for taking my questions here. A couple of quick questions here. Michael, could you give us an update on the ten deals that you spoke about on July 6th as to where we are. I know, I understand that you closed one big deal. And then John, could you help us understand by how much of the core operating expenses decreased in Q3 and Q4? Thanks.

Well, we mentioned -- as I mentioned briefly, we have closed one seven-figure transaction. At this point, obviously, since we are in the middle of a quarter being anymore specific than that, we really can't be. We are very confident though in the growth of our pipeline amongst these larger transactions. We have a significant number of them. In fact, in the last call, I mentioned that we were looking -- working on about -- we're working on a number of seven-figure transactions that we were focused on for the second half of the year and a number of them have compelling events in the second half of the year such as retailers focused on the holiday season, insurance companies focused on open enrollment. Things of that nature. We are still working very diligently on those trends -- those transactions. The great news is that over 80% of them are our customers. Interestingly, the one that we mentioned that we've closed is new to us. So, we're excited about that. We still are looking for great success coming out of the pipeline for the second half.

Nick, relative to the expenses, while we give guidance on the revenue side, we don't give guidance on the expenses. I did mention that we expected them to be down because of the cuts that we made that we announced on July 6th. At the same time, we are continuing to hire at a relatively slow rate but a selective hiring in areas where we believe that it makes sense for the long-term and we've also said that our goal is to be profitable for the year. That's about all I can say on that.

All right. Couple of quick follow-up questions. Could you give any more color on the breakdown of the maintenance and professional services revenue and what is the cash flow from operations, how much cash did you burn? And also, I know you don't give guidance on services margin but where should we expect to see it at, call it the 65 to 70% levels or how should we think about that? Thanks.

Let's see. Sorry, Nick, I got lost.

Actually, it is just three-part question. What is the maintenance and services revenue breakdown?

We don't break those out. We just call it services.

Ok. And what is the cash burn from cash flow from operations?

Well, our borrowing went up but it went up in part because of the eVergance acquisition.

Ok.

So, I think there's about 1.5 million that we borrowed in part for the initial cash payment to them plus paying off a bank line that they had had. So, that was part of the increase in our bank loan.

Ok.

The actual cash burn gets muddled in the middle of all of that. We don't really talk about cash burn. We just let people take a look at our financial statements when we file them in the 10-K and take a look at it.

Ok. Lastly, in the services margin. Should we expect it to stay in the 65 to 70% levels or how should we think about that?

The margin is made up of two things. One is the technical support -- I mean the maintenance or technical support part of the services.

Right.

That is growing actually fairly nicely right now in terms of revenue. Expenses will probably hold about the same. And on the services side, the rest of the pieces of services is OnDemand and there were some additional costs on the OnDemand side as we staff that up for the orders that we've gotten and the growth that we would expect to see going forward. And then the third piece is the professional services. Now, we only had a small portion of the eVergance come in, about less than a half a month's worth in Q2 and that was added to our existing professional services. So, you've got three pieces that move around in terms of the services part of our business. You have the technical support, you have OnDemand and you have what I would call consulting, which is our own professional services from KANA plus eVergance. So, there's three pieces that move around.

Right. So putting it together, would you think that it 's going to be the blended services gross margin, would that be in the 70% levels?

Well, we haven't predicted it yet.

Ok. All right.

Your next question comes from the line of Michael Huang of ThinkEquity.

Thank you very much. Hey, guys.

Hi, Michael. .

Few questions for you. So first, in terms of the spending catalyst you could see in Q3, obviously you've highlighted a couple, but wanted to understand whether or not that the federal sector end of year, is that something that could drive performance in Q3? And maybe just a follow-on question to that, could you help us understand what the vertical breakout was in the quarter?

Well, the -- our efforts in the federal markets are very new in terms of focused efforts. So, we have, of course, an important transaction that we just announced today. But when we look at growth in the federal marketplace for us it's going to really take time for it to start becoming a significant part of the business. So, when I look at the federal calendar which ends in September of the effect on the additional effect on the quarter will probably be diminutive. I doubt that'll be the case when we look at the ending federal calendar in 2008.

Right.

And from a vertical breakdown from last quarter, we really haven't presented those kinds of numbers before. I would say to you that we continue to see the significant part of our revenues that come from the financial services and telecommunications sector and you can just see that in the names that we listed as companies who bought our technology in Q2. But we haven't given any guidance on how those verticals have broken down.

Great.

Mike mentioned we had ING, we had Capital One, MMO2, Cingular, ATT, et cetera. Those are the ones that are at the top and fall into those two verticals.

So, to per the competitive displacement at the U.S. post office, could you help us understand the driving factors behind the switch? Was it strictly because they wanted On Premise or was there anything else in there?

Probably a combination of things that we see typically. Number one, we firmly believe that when it comes to industrial strength functionality, be it OnDemand or On Premise that, we have the best products in the market. When the customers really interested in deep offering capabilities, highly scalable solutions, we really drive that much better. We're seeing an interesting trend though, at least we're hearing now, in the federal market. We're starting actually to see this in some of the commercial markets with larger companies. And that's the issue of the control of confidential information and where that control lies. It's a big issue in the federal marketplace of looking to how -- when information about their clients, of course, being citizens of the U.S. or in other countries, who actually is in control of that information. And it's difficult for OnDemand solutions to be able to meet that standard. They might be able to meet it technically, but there are compliance issues that are just written in federal statute about where information can be managed and so we're seeing some Premise-base requests taking place just because of the need to be able to control the information behind the firewall of the agency.

Great. And per this joint study that you alluded to with IBM that you've recently concluded, it seems that you were focused just on financial services in North America. Is there an opportunity for a broadening scope beyond that so international or other verticals and also could you quantify how this has impacted pipeline? Is it too early to say or are you already seeing some pipeline opportunities as a result of this?

Yes, first, on the second part of your question, from the 72, we've already seen a substantial number of opportunities come from that. Some of them just, the process was, we did the study, we jointly sent letters to the senior executives of those organizations informing them of what we found out and we have received a significant number of responses about let's start a more detailed investigation of this and how we can resolve that issue. Most large companies really had not taken a look at this in a purely analytical way of how they would be positioned against best practices for customer service. So, they may have thought they had great service until they saw how they were positioned. So, this is really leading, we think, to great opportunities for both us and them. On the first part, of are we doing any more, well absolutely. In fact, we've already started the process in the U.K. and we're in the middle of doing some studies there. I just met today with two senior executives of IBM and we were discussing different strategies where we would cooperate on this kind of activity on several fronts. Not just this study but some other activities that you'll see us start to roll out over the next six to 12 months.

Great. And last question that I have for you, could you provide us with the -- in terms of the 51 deals that were done in the quarter, could you help us understand whether kind the of -- where when you look at mix of those types of deals versus kind of the pipeline whether or not there are any noticeable differences in terms of competition versus competition in the pipeline? Thanks.

No. I mean they came through the pipeline. I mean we're starting to see now what we expected and that's the sales force as they gain experience in their territories and with their clients and with their prospect base, building the right kinds of pursuit strategies and beginning now to close that business, what we haven't seen as craftedly as we expected were the larger transactions closing the first half. Now we're starting to see results from the efforts that we put in place over the last six to nine months. It takes a bit longer to get those kinds of transactions done. But as that process begins, we're also seeing the growth in the pipeline. So we think as we start to close them that it will be much more of a repetitive process and the strength of that sweet spot core business growing, as I said a year ago, I want to get to a place where our sales reps, every quarter, are closing 3, 4, $500,000 transactions and then once a year, they're doing a large transaction. If we can do that on a repetitive basis, then I can start giving quarterly guidance but we didn't do it this year because we know we're in a lumpy world and we're in the middle of a turnaround.

Great. Thanks very much, guys.

Your next question comes from the line of Derrick Wood of Pacific Growth Equities.

Hi, thanks. Just a quick question. Was curious about what your go to market strategies are for your OnDemand product. Is that a product that you could see some fairly big bookings, deals out of or is that something that you're really trying to go to in the mid market? And then if you can just kind of touch on what solutions are the most popular in the OnDemand deployment?

The way we're going to market with OnDemand, since it is a relatively new concept for us, our focus is more on offering to the customer an alternative solutions based on what their deployment strategy is. We look at OnDemand more as a deployment strategy rather than a product. We have functionality within our OnDemand product that meets the goals and demands of companies of different types. We also have that in our Premise-based solutions. And when we talk to a customer about what their requirements are and how they plan to deploy these solutions that's how this comes out and what's the best fit for them. And so we're not at this time looking at OnDemand as a product environment. It's a deployment strategy rather than a product environment for us.

As a follow-up, is your named account sales force able to sell both the OnDemand and the On Premise?

The named account sales force can sell OnDemand or Premise-based solutions to their named accounts. Again, it depends on what the customer's strategy is. Now, clearly, our inside sales force will find with their focus on both mid-market and non-named accounts that there will be -- they may have more situations that would lend itself towards OnDemand. But the field sales force is responsible for named accounts. And that means all of the products and services that we offer, we would expect them to own the relationship management with that account to ensure that the right products and services from KANA is available to that client. And that, of course, includes the service components that eVergance, the strategic service and management consulting services that eVergance can offer the customer as well.

Ok, great, thank you.

And your next question comes from the line of Gregg Speicher of Moss Creek.

Hi, guys, good afternoon.

Hi, Greg.

Can I clarify one thing. Did you say for the U.S. Post Office, did you say they had to switch because of legal issues or there were technological issues that didn't allow them to do something correctly?

I think the question was what are we seeing relative to OnDemand when I talked about the fact that there are some customers that are, particularly in the federal marketplace, that's looking at the issue of the compliance standard for who owns the data. Actually, that's less of an issue in the U.S. Post Office because they don't, for the most part, for example, in health and human services, relevant to patient records, that's a different issue than what you might find in the U.S. Post Office. So, I wasn't talking specifically to the U.S. Post Office.

Ok.

In that case, there were, we think, technical issues that when they looked at their next level of deployment that they wanted to do and how they wanted to be able to offer knowledge, manage the scale of implementation that they wanted, that our solution was the best solution.

Ok. Fair enough. Do you expect license growth for the year? Can you go into that detail?

Yes, we do. Absolutely.

Ok. All right. Do you care to say how many OnDemand customers you have at this point?

No. But we have a number of them. I know that doesn't say much to you but we've seen some substantive growth this year in our OnDemand. It's still, I don't want to mislead you, it is still substantively small relevant to our On Premise based customer list. But, we think it's a growth market for us.

Ok. I mean the guess the one question is there any cannibalization? Are you losing some license revenues to the people who go OnDemand otherwise?

We haven't yet.

Ok.

But, again, it depends on how the customer wants to deploy their solutions. The customers that are already driving an On Premise solution, I think the reason why we haven't yet is that they would have to be looking for different functionality, better functionality to get out of OnDemand which we believe we have the best solution. So, it is going to be OnDemand or On Premise, and if you're already operating in an On Premise environment, we tend to find that customers that are trying maybe something new or they have a departmental issue and they want to get up quickly, we've had some customers that have talked to us about well, we want to do OnDemand for the first four months because getting our internal IT operational is going to take that period of time and we don't want to lose the value time of the implementation of your technology. So, we've seen that as well. So we want to leave this decision as a deployment decision for our customers rather than as a defined product objective.

Ok. Last question. One of the times we've chatted fairly recently, I suppose, you guys talked about building out different pieces of your license platform. Are you happy with where all of the products are right now?

We're in the software business. If you're ever happy with where you are then you're probably in trouble. We believe that we have the state-of-the-art technology today but we also know that we need to continue to improve that if we want to stay ahead. So, we are looking at a number of objectives, particularly around total solution integration, more capabilities in the contact center. Even in the areas that we know we're way ahead of competition, particularly in things such as e-mail management we're in great shape there as well.

Ok. Thanks a lot.

And you have no questions at this time. I would now like to turn the call back over to management for closing remarks.

Thank you, everyone and before we sign off, I'd like to point out that members of KANA's management team will be presenting at the ThinkEquity conference on Thursday, August 2nd in New York. And we look forward to seeing many of you there. Thanks for your time today. And we look forward to talking to you all again soon. Bye.

Thank you for your participation in today's conference. This concludes the presentation, and you may now disconnect.