Mattersight Management Discusses Q3 2013 Results - Earnings Call Transcript

Nov. 6.13 | About: Mattersight Corporation (MATR)

Mattersight (NASDAQ:MATR)

Q3 2013 Earnings Call

November 06, 2013 5:00 pm ET

Executives

Kelly D. Conway - Chief Executive Officer, President and Director

Mark Andrew Iserloth - Chief Financial Officer and Vice President

Analysts

Jonathan Ho - William Blair & Company L.L.C., Research Division

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

Operator

Good afternoon. My name is Candice, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mattersight Q3 2013 Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Kelly Conway, President and Chief Executive Officer. You may begin.

Kelly D. Conway

Thank you, everyone, and thank you for joining us for Mattersight's Q3 2013 earnings conference call and webinar. Joining me on the call today is Mark Iserloth, our Chief Financial Officer. Before we start the call, Mark, would you please review the Safe Harbor language?

Mark Andrew Iserloth

Thanks, Kelly. During today's call, we will be making both historical and forward-looking statements in order to help you better understand our business. These forward-looking statements include references to our plans, intentions, expectations, beliefs, strategies and objectives. Any forward-looking statements speak only as of today's date. In addition, these forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those stated or implied by these forward-looking statements.

The risks and uncertainties associated with our business are highlighted in our filings with the SEC, including our Annual Report filed on Form 10-K for the year ended December 31, 2012, our quarterly reports on Form 10-Q as well as our press release issued earlier today. Mattersight Corporation undertakes no obligation to publicly update or revise any forward-looking statements in this call. Also, be advised that this call is being recorded and is copyrighted by Mattersight Corporation. Kelly?

Kelly D. Conway

Thanks, Mark. I'd like to review our progress in Q3. We're very pleased with the progress that we had in Q3 and our achievements across numerous fronts. We had very strong bookings, another strong bookings quarter. We booked $3.8 million in incremental Annual Contract Value, bringing our year-to-date incremental ACV bookings are up 115% over the same period in 2012.

From a revenue perspective, we also had a very good quarter. Our revenues were $8.6 million in the quarter, up 9% sequentially; and our subscriptions were up 6% sequentially.

We're very pleased to report that we reported and achieved approximately $300,000 of positive adjusted EBITDA and continue to have strong expansion of our gross margins. In the quarter, we achieved record gross margins of 68%, which were up 180 basis points sequentially. We also strengthened our balance sheet, and we ended the quarter with $13.7 million in cash.

Notably, we had a very strong quarter, in fact, the best quarter ever for pilots. We closed 17 new pilots which were all Predictive Behavioral Routing. We ended the quarter with our total pilot count up 50% sequentially to a record of 33, and our follow-on ACD from those pilots grew 80% sequentially over Q2. Again, strong performance across all major indicators in the quarter.

Mark, why don’t you review the booking highlights and financial highlights in the third quarter?

Mark Andrew Iserloth

Thanks, Kelly. As Kelly mentioned, we had a strong bookings quarter of $3.8 million in incremental ACV, and he mentioned the year-to-date total of $9.9 million. Underneath that, we had excellent breadth. So we had no deal -- sorry, we had 5 deals over $250,000 in incremental ACV and no deals over $800,000 in ACV. In fact, we've only had 1 deal over $800,000 for the entire year. We had 14 in the range between $250,000 and $800,000. This compares to all 2012, where we did $6.5 million in incremental ACV and we had 1 deal over a $1 million dollars. So our depth was a little bit different in 2012.

Bookings, as a mix, were primarily driven by add-on orders for our performance management offering. So as excited as we are about our routing, we haven't seen that hit our bookings number or income statement yet, and the bookings to-date had been for existing business.

As -- on the pilot side, we converted 2 pilots. The first one was a real-time compliance application for a financial services organization who was looking to achieve real-time compliance goals inside their organization. We also had an OEM agreement, which is going to use our algorithms for a hiring application that we rolled out later on this year. This may not initially be large in terms of dollars, but it's a fantastic avenue we have not had before, and it could be interesting over time as we grow that part of the business.

As Kelly talked about, and I'll give more detail in a moment, we added 17 new pilots. Of those 17, 9 were new logos, and we ended the quarter with a record of 33 active pilots.

On the income statement and balance sheet, as Kelly mentioned, we had $8.6 million of revenue and our total revenue was up 9% and subscription up 6%. Included in that is a one-time early termination fee of approximately $475,000. Without that, the growth rate would have been 3%, which is slightly lower than the guidance of 4% to 5% we gave at the end of the last quarter, and that was primarily due to the timing of a client we'll see in Q4.

We did have record gross margins both overall at 68% and within our subscription line of 76%, which is up 150 basis points from Q2. As we have an increasing mix of business skewed towards subscription and as performance management -- I'm sorry, as Predictive Routing becomes more online, we expect that to move up from there.

We do have an adjusted EBITDA positive quarter of $300,000, which was an improvement of $700,000 from our results in Q2 and our first positive quarter; and we had an improved balance sheet. As Kelly mentioned, we generated $6 million in free cash flow and ended the quarter with $13.7 million in cash.

On our book of business, this is a metric we rolled out last quarter, and we tweaked it a little bit so I'll spend a moment describing exactly what it is. We made it a little bit clear, we think, such that it rolls over period-to-period.

In Q2, when we rolled it out, we had a reset essentially each quarter. We changed the metric a little bit, and I'll explain exactly what the $9.3 million means at the end of Q3. What it effectively shows is that if we -- at the end of Q3, if we did not sell another thing and everything stayed online, then as the incremental bookings and as deployments that were currently in flight land in our income statement, the current run rate of our business equals $9.3 million. On -- overall, our normalized Q3 rate, that's about a 14% growth rate, which bodes well for the future. It also shows that it follows a little bit the bookings line underneath it, which shows a low of $400,000 last Q3 and a high of $3.8 million this Q3.

On our pilots, as Kelly mentioned, we haven't broken it down here, but we added 17 new pilots in Q3. They were all performance management. 13 of those were -- I'm sorry, they were all Predictive Routing. 13 of those were impact analysis pilots, and 4 of those were routing appliance, which, as we talked about before, is effectively the second stage of a pilot prior to conversion to subscription.

We had 2 pilots on the routing side dropped, 1 on the impact analysis, 1 on the appliance. And so we have a total of 23 at the end of the quarter, of which 9 were new logos. We maintained -- we still had 4 in the performance management side. And in the add-on or other, we had 10, 2 of which converted, which I touched on; 2 of which dropped, so leaving a total of 6. So a total at the end of the quarter of 33 outstanding pilots.

A couple of points on the pilot activity. The pilot activity is up 50% from Q2 to Q3, which is the highest growth rate we've seen in our history. We added on the pipeline, which is suggestive of future success. We added 35 routing opportunities in Q2, 52 in Q3. And to-date in Q4 through October, we added 24 additional in October. We are currently seeing demand for approximately 30 meetings per month for routing, and we're doing with just 1 ISR. And we had -- and we're seeing strong activity across numerous verticals. So as an application as an offering, this is actually getting more traction in broader market verticals we see to-date, healthcare, TC [ph], tech telecom, education, all broader than our initial or core performance management routing.

We're also seeing growing mid-market interest for routing, and we're -- that's part of the pipeline activity that I was describing before. And a further indication of how well this is being received is we're seeing a broad interest in a number of applications. So it's not just cost reduction, it's increase in sales, customer retention and collections.

Kelly mentioned the follow-on ACV. What this chart represents is, at the end of a period, we take a look at the immediate opportunity that we could contract for if the pilots convert. As you can see, between Q3 of 2012 and Q2 of 2013, there was a slight growth from approximately $10 million to approximately $12 million. Given the activity we had in 2013's third quarter, we grew that 80% and it's approximately $21 million as a follow-on conversion value of the pipeline, again, a strong interest for future growth -- strong indicator of future growth.

Kelly?

Kelly D. Conway

Great. Well, as you can see from the description of Mark talked about, both in our traditional Behavioral Analytics applications as well as the explosive interest in routing, we have seen a significant uptick in bookings activity and pipeline interest. And I think it really relates to the unique positioning we've developed over the last several years, and I wanted to review that with people, kind of how we think about the unique positioning we have and what's really the combination of those things which has ignited our pipeline.

Our pipe -- our technology platform has really expanded and it's a combination of big data, behavioral analysis, so that behavioral analysis is understanding personalities and behavioral pairing, predictive modeling and real-time execution applications. And let me just talk a little bit about each of these.

So big data in our platform is bringing in conversations as well as increasingly a lot of targeted textual data; desktop usage data; IVR and weblogs in -- is starting to emerge as an important data source; and customer data, as part of all going into our platform.

The important elements of behavioral analysis is scoring each call for customer personality and sentiment and then how -- over thousands of calls, how each employee connects to different customer types. The important predictive modeling that we're doing and we're really seeing uptick in predictive modeling across all of our client base is predicting customer satisfaction, net promoter score and things like probability of customer attrition.

And finally, with such [ph] extreme interest of people who's using all this data in real-time execution without any human intervention. So those are a great application obviously as routing, where our application uses all of this data and pulls it together in each call and predicts who is the best customer service representative to take a customer's call, as well as the number of real-time alerting applications, one of which that Mark alluded to which is doing real-time compliance monitoring and financial services, where we're able to spit out alerts in near real-time when conversations with customers have non-compliant elements to it. So it's really the combinations, again, of this big data, behavioral analysis, predictive modeling and real-time execution, which is truly unique, and I think explains why we have strong demand for our existing application and why routing is so hot a topic as we go forward.

Mark?

Mark Andrew Iserloth

Thanks, Kelly. So in summary, relative to the tone of the business, we're very optimistic and encouraged by our progress to-date. Our pipeline for our current products remains solid, as evidenced by our bookings success with our existing offering more or so than what the -- what we think will be upcoming in Predictive Routing. We have a very strong interest in routing as indicated by the pilots and the pipeline growth. GDIT remains a question mark for us. We can talk about that if there -- if you'd like, in the Q&A. But as we've talked about in the past, we'll know more at the end of the quarter, and it's unlikely that we'll know more before the end of the quarter.

Relative to Q4, we currently expect Q4 subscription revenues will increase sequentially by 7%, and we should have another strong quarter.

Kelly?

Kelly D. Conway

Operator, we'd now like to open up the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from Jonathan Ho with William Blair.

Jonathan Ho - William Blair & Company L.L.C., Research Division

So just leading off with a couple of questions around sort of the 33 new pilots that are currently in the pipeline. How seriously [ph] should we expect some of the ones that were signed earlier on, I think it was 22 at the end of the last quarter, to start converting automatically into paid pilots or into full-paid subscriptions at this point?

Kelly D. Conway

Yes. We'll really -- Jonathan, I think we'll really see later in the fourth quarter and more particularly in the first quarter that our pilot conversion schedule is when we would predict those. We have a predictive conversion date for each of them. And as I said, I think some of them should convert or target to occur late in the fourth, but more likely in the first quarter.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Got it. So is there sort of an average life that you can maybe share with us when somebody starts a pilot, what the life of that pilot is relative to the automation?

Kelly D. Conway

Well, so on the routing side, Jonathan, which I'm assuming that's where the focus of your question is. And frankly, going forward, that will probably mean with 90% of our pilots will probably be in the routing area. We estimate that once a customer puts in our technology that it will probably be kind of 1 to 3 months to get that from a pilot to a converted subscription. We have several of those. We expect to go in Q4 frankly that are kind of -- I think within the next few weeks that they should go in.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Got it, got it. And just to talk a little bit about sort of the math around the ACV. I appreciate the additional disclosure. But I mean, I guess, from our perspective, it looks like you've added approximately a little bit less than $8 million worth of ACV in the last 2 quarters. Can you walk through the math with us in terms of why we wouldn't see then the $2 million per quarter in terms of incremental revenue following the signing of the ACV? What is it that falls in or falls out that causes that not to be the case? Just wanted to get a sense around the math of that as we look at the subscription revenue line.

Kelly D. Conway

Mark, do you want to take that one?

Mark Andrew Iserloth

Sure. The way I would think about it, Jonathan, is that there is -- some of the pilots that have been -- that were outstanding at the end of Q2 are some of the older performance management pilots as opposed to the routing pilots, which typically have a longer lead time before they hit the income statement. I think that the time of a pilot, meaning that the average length of time that a pilot exists is going to come down significantly as we see a mix skewed towards the routing side of things. And if you'll notice, the pilot level really hasn't changed much in the last few quarters until a little bit in Q2 and then more significantly in Q3. So we're really looking for that uptick to happen more sort of the part of next -- later part of next -- I'm sorry, after the end -- towards the first half of next year. So as Kelly described it, to your question earlier, we had about 5 of these outstanding at the end of Q2, 5 new ones. Those would be in the window to convert in Q4 -- end of Q4, beginning of Q1; and we should see the ones that we've signed more recently than end of Q1, beginning of Q2. So we expect more growth in the income statement as a result of the pilots, again, towards the end of the first half of next year. Does that help?

Jonathan Ho - William Blair & Company L.L.C., Research Division

Absolutely, absolutely. That's actually very helpful. Last one for me, just in terms of the $475,000 early termination fee, what's that related to? And does that show up at all in the subscription line in terms of revenue?

Mark Andrew Iserloth

A portion of it shows up in subscription, but it's in both subscription and deployment. The one it's related to is a client who is undergoing a, sort of, redo of their infrastructure. And as such, they was -- they're sort of putting everything on hold that they're doing right now. They will be opening it up again for new architecture and rebid, and we'll be part of the rebid process, which wouldn't happen probably till the second half of next year. So it was actually more economical for them to terminate the contract early and then go after a rebid at the end of next -- second half of next year.

Jonathan Ho - William Blair & Company L.L.C., Research Division

Okay. So they were pre-existing customer then? Can you maybe give us a sense of how much they were contributing to the subscription line on an annual basis?

Mark Andrew Iserloth

Yes. So they would -- less than $0.5 million on an annual basis.

Operator

And your next question comes from George Sutton with Craig-Hallum.

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

So relative to the appliance piece of the equation, that really didn't come up much on the call other than 1 of your pilots, I think, in that area went away. So my sense was that was going to accelerate some of the opportunities for you because really there's much less IT involvement. Can you just give us an update on that?

Kelly D. Conway

Well, we continue to believe that's the case, the sales cycle that we have for routing looks like this is, is that the first stage of our pilot is an in-depth analysis of a client's data, where we'll project how much benefit we would -- we drive. That generally takes about 2 weeks. We've seen a very high receptivity. Generally, that data set projects about an 8% to 12% increase in sales improvement and retention or decrease in cost. So those have been very highly well received. The next step is to negotiate that appliance pilot because it converts into a subscription. Sometimes that becomes a real contract, in fact. And we estimate that those will take, on average, 8 weeks, to move from the first phase of the pilot to the second phase. Once that's signed, we would think it would take around 4 to 6 weeks to put the appliance in and turn it on and then run it 1 to 2 months, George, is the -- that's the projected cycle that we have. Now we have to say we're still in the early days of this. And as we get more references and more FAQs and have built more connectors, I think we'll be more towards that idealized schedule. In some of these cases, if it's a new architecture we haven't seen, there's more technology work for the first time that you have to set it up. But what I've described is kind of what we're really shooting for in our idealized revenue model.

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

Got you. And of the 33 active pilots you have, could you give us a sense of how many of those are appliance pilots? Or is that, let's say, yet to come in terms of the real impact?

Kelly D. Conway

I can tell you that, if you just hold on just a second. We currently have 5 appliance pilots.

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

Okay. And if we think out a year, will that be a fairly significant portion of your pilots, in your view?

Kelly D. Conway

The appliance pilots?

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

Correct.

Kelly D. Conway

Yes. I mean, we -- so we -- if you look at it, we added 17 new pilots in Q3. We think that we -- that there's almost an unlimited demand for this at this point. So if we execute well on our sales and marketing, either that number could be significantly higher on a cumulative basis. What we're not absolutely sure of -- and let's imagine that each of those pilots has an average Annual Contract Value of $500,000 to $600,000 associated with that, the follow-on. What we don't know is what the conversion rate is going to be out of those. But it could create a very significant pipeline to harvest from, George, if you just kind of run the math of doing more than 17 at an average of $500,000 to $600,000 value for each of those.

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

Right. Well, I'm a sucker for the term unlimited demand. So you had mentioned 30 meetings per month for routing with 1 ISR and it just dawned on me, being a simpleton, that maybe you could use a second ISR? Or is there not enough to suggest that another ISR would give you a much larger number of potential...

Kelly D. Conway

I think that's something that we would -- frankly, the market demand -- market response to Predictive Behavioral Routing has exceeded all of our expectations at the top end of the funnel. And I would expect that we would add more ISR resource to create more demand for meetings and ultimately that creates more pilots and more pipeline and more opportunities to convert.

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

Got you. Okay. Mark, you effectively asked for us to ask relative to the General Dynamics update, if you could just give us a sense of where that stands.

Mark Andrew Iserloth

Kelly, you or me? I'll go ahead and take that. Yes, I -- it continues to remain somewhat uncertain of what CMS wants to do and what GDIT wants to do and, frankly, the status of the whole Affordable Care Act. So we remain an important part of what GDIT is doing for CMS. GDIT views this as very strategic. I think that they are in the process of -- first of all, they are overwhelmed with the work that they are getting, particularly in light of the fact that the website is not working and that generated a significant amount of incremental phone demand. We're in the process, I think, for the next month or 2 of working with GDIT to understand what CMS wants to do going forward. I can tell you that GDIT believes that our analytics are an essential part of them running the program. And so, we just need to get with -- frankly, GDIT needs to just get ironed out with CMS, kind of how they see this all going forward. And you can imagine that everybody has got their hands full and are very busy with the rollout and the way it's gone and all the publicity. So that's what I can tell you. GDIT thinks we're very vital with what they're doing, and -- but it's just not clear how it's going to sort out and over what timeframe it's going to go -- sort out, given how busy everybody is.

Operator

[Operator Instructions]

Kelly D. Conway

While there's a slight pause, let me just make sure I clarified one comment that I made to Jonathan's question regarding the run rate of the client. I had mentioned it was $0.5 million and the way I think about it and the way we talked about it is, on a subscription basis, it's a little bit more in that if you include some amortized deployment.

Operator

And we have no further questions on the line. I'll turn the call back over to our presenters.

Mark Andrew Iserloth

Kelly?

Kelly D. Conway

Yes? Are there other questions?

Mark Andrew Iserloth

No, I think we're good.

Operator

We have no further questions on the line.

Kelly D. Conway

Candice, maybe -- oftentimes, there is people that are caught up looking to ask other questions. Perhaps you could poll one more time for questions.

Operator

[Operator Instructions]

Kelly D. Conway

Great. Well, we appreciate everybody's interest. We're extremely pleased with the progress we made and the outlook that we had. Very strong bookings performance, the second quarter in a row. Our pilot activity is at a record level. The market reception of routing has exceeded all of our expectations. And obviously, we're pleased with the improved gross margins and improved operating performance and strength that we had in the balance sheet in the third quarter. And we look forward to working hard in the fourth quarter and talking to you again soon. Thanks so much. Take care. Bye-bye.

Operator

And this concludes today's conference call. You may now disconnect.

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