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Rightnow Technologies (NASDAQ:RNOW)

Q3 2010 Earnings Call

October 28, 2010 4:30 pm ET

Executives

Jeffrey Davison - Chief Financial Officer, Principal Accounting Officer, Vice President and Treasurer

Greg Gianforte - Founder, Chairman and Chief Executive Officer

Todd Friedman - Managing Director

Analysts

Laura Lederman - William Blair & Company L.L.C.

Keith Weiss - Morgan Stanley

David Hilal - FBR Capital Markets & Co.

Mark Murphy - Piper Jaffray Companies

Tom Roderick - Stifel, Nicolaus & Co., Inc.

Goran Vasiljevic - Roth Capital Partners

Operator

Good day, ladies and gentlemen, and welcome to the RightNow Technologies Third Quarter 2010 Earnings Call. [Operator Instructions] And now I would like to introduce your host for today, Todd Friedman of Investor Relations.

Todd Friedman

Thanks, John. Good afternoon, everybody, and thank you all for joining us on RightNow's third quarter 2010 conference call. Joining me on the call today is CEO and Founder, Greg Gianforte; and Chief Financial Officer, Jeff Davison.

Before turning the call over to the company, I'll read our Safe Harbor statement. During the course of this call, we may make projections of forward-looking statements regarding future conditions or events, which may drive our future business, current and new products and services and their performance, the size and strength of our market and our future financial performance and outlook for the company. These forward-looking statements may include, but are not limited to statements about revenue growth and profitability, our future strategic plans and perceived growth opportunities, market acceptance of our products and other statements relating to our operating results.

These forward-looking statements speak only as of today and are based upon the information currently available to us. This information will likely change over time. By discussing our current perception of our market and the future performance of the company and our products with you today, we are not undertaking the obligation to provide updates in the future. We caution you that such statements are just projections and actual results and events may differ materially from what we discuss today. Please refer to the documents we file with the SEC, specifically our most recent annual report on Form 10-K and quarterly reports on Form 10-Q. These documents contain and identify important factors that could cause actual results to differ materially from those contained in our projections and forward-looking statements.

As a reminder, we are providing a supplemental data sheet for easy reference on our Investor Relations section of our website that contains historical information and other key metrics that we'll be discussing on the call today. In addition, an updated Investor Presentation has also been posted to the site. During the course of the call, we will also be discussing certain non-GAAP financial results. We direct your attention to our reconciliations of GAAP, which can be found in our company’s earnings release, which is posted on the Investor Relations portion of our website.

And with that, I'll turn the call over to Greg.

Greg Gianforte

Thank you, Todd, and good afternoon, everyone. As you saw a couple of weeks ago from our pre-announcement, we had terrific third quarter with continued growth in revenue, recurring revenue and EPS. I'll keep my remarks brief today since we saw many of you saw at the Summit, our User Conference in Colorado Springs.

For those of you who did attended the event, it was great to see you, and I hope you got a first-hand view of the momentum in our business and the passion in our customer base. For those of you who are unable to be there in person, the webcast from our Analyst Day is still available on our IR site and some keynote videos are still available on the website as well.

There are four primary points I want to cover on the call today. First, we are executing well against our financial goals. Secondly, as we lay out on our Analyst Day, our growth is being fueled by the momentum in our core business, which is benefiting from a tailwind of four mega trends that I'll discuss. Third, we introduced Wayne Huyard at the Summit as our new President and Chief Operating Officer. And fourth, we believe the business outlook remains strong. We're continuing to invest across the entire business, but you'll notice a definite shift in our focus to investing more in sales and marketing as we move forward.

Let me start with some of our key financial metrics, which in the final quarterly accounting, we're slightly ahead of our preliminary results. Recurring revenue, a key measure of our growth increased 13% over Q3 a year ago, which we believe continues to be amongst the highest of the SaaS vendors. We've made a tremendous progress over the last year and a half. And you can clearly see how we're gaining momentum and leverage in the model. Both revenue and EPS were above guidance. Revenue for the quarter was $48.6 million and non-GAAP EPS was $0.15. We also had 17 deals over $1 million in the quarter.

Next, let me take a few minutes and talk about the key points from our Summit, and I'll focus on the four mega trends that I outlined there. You recall our top level message that we're continuing to invest for profitable growth. Over the years, we've made significant investments throughout our organization to drive solution leadership, sales capacity and competitive differentiation. These investments have created scale in the business while driving continued momentum. We believe these investments also squarely positioned us to take advantage of the four key mega trends that are creating a very large opportunity for us within the customer experience market.

The first two of these we've spoken about repeatedly in the past, the rise of the empowered consumer and the widespread adoption of cloud computing. I want to spend a minute talking about the third and fourth mega trends and relate some customer interactions from the summit. The third mega trend fueling our growth is the proliferation of online interactions. Mobile devices are enabling consumers to access information anywhere, anytime, increasing the pressure on B-to-C organizations to quickly incorporate mobile into their overall customer interaction strategy.

Consumers now have the ability to check the status of shipments on smartphones, make buying decisions with tablets and post reviews and tweets while standing in line at the grocery store. An organization needs to be prepared to service consumers in this new environment and response times are critical. Industry analysts project that mobile Internet users will surpass PC Internet users in just a few years, increasing the demand on our customers and raising the critical need for an integrated CX solution. This trend will increase interactions between our customers and their consumers. And as you know, approximately half of our revenue comes from interaction-based pricing.

The fourth trend is a contact center replacement cycle. High-volume B-to-C contact centers need to replace their aging on premise software and they need to do it quickly. Those of you who are in Colorado Springs heard Toshiba talk about how they whipped out their old on-premise system and replaced it with 600 seats of RightNow CX in conjunction with our partner TelePerformance. Toshiba and others like RealNetworks spoke at the Summit to hundreds of other customers and prospects about the benefit of pulling the plug on their legacy aged desktop and moving to our solution.

As you imagine, a key theme at the users conference was encouraging customers to throw out the old Siebel deployments and replace them with a multichannel solution to accommodate today's customer service requirements. Companies can't afford to just replace old technology though. They need to implement a customer experience strategy that includes a web self-service, mobile, social, chat and the contact center.

At the summit, we also announced the important addition to the executive leadership team. We introduced Wayne Huyard as President and Chief Operating Officer. Wayne is a proven leader with more than 25 years of executive experience and he will have primary responsibility for RightNow's sales and marketing, service, engineering and operations organization. He's been with the company since July and has a unique opportunity to know the company. By interviewing employees across all departments and to help develop our strategy for solid, long-term profitable growth. I'm personally excited to have Wayne on our executive team.

I'll wrap up with a comment about our outlook. I firmly believe our business is stronger today than anytime in our history. Those of you who stayed for the summit heard this firsthand from customers and partners. We're focused squarely on expanding our presence in the marketplace and setting a new standard for how high-volume B-to-C organizations interact with their customers. Whether it's our solution set, our customer base, our balance sheet, our competitive position, our business is operating a higher level than ever before. We're on track for our strongest full year recurring revenue growth in three years, which is the clearest indication of the overall strength throughout the business. We're committed to scaling the business and hitting our 18% target operating margin in Q4 2011.

But let me be clear, we're also committed to growing the top line as well. To that end, we're investing to grow recurring revenue by 20% in 2011. We're excited about the breath and depth of the opportunities in front of us. And with that, I'll turn the call over to Jeff.

Jeffrey Davison

Thank you, Greg. Good afternoon, everyone. Revenue in the third quarter was $48.6 million, 25% higher than Q3 of 2009. Recurring revenue was $38.6 million, an 11% sequential increase over last quarter and a 30% increase over the third quarter of last year. I'll make one note on Q3 revenue. While most of our recurring revenue in each quarter comes from backlog, the course of the revenue is from contract signing in the quarter. The amount is really a function of when the contract was signed and to some extent, uses charges.

In Q3, the amount of in-quarter revenue exceeded historical levels which helped drive some of the upside. While the same token, we do not expect the same sequential growth in Q4. We also saw a positive impact from foreign exchange of approximately $500,000 in the third quarter.

Professional service revenue was approximately $10 million for the quarter. We reported a record total backlog of $252 million, an increase of 19% over Q2 and a 52% increase over Q3 of last year. Current backlog at the end of the quarter was $134 million. Starting today, we will provide a little more color on the composition of current backlog. The software portion of current backlog at the end of the quarter was $118 million, which is 22% greater than Q3 2009 and on a trailing 12-month basis is up 23% over one year ago. We combined this and the historical information on our data sheets.

Average term link in the quarter was 37 months, which was impacted by one large deal that had a five-year term. We added 66 new customers as we continue target high new quality large customers while expanding relationships with existing customers.

New expansion and renewal business came from customers including Audiovox, Barclaycard U.S., CyberDefender, DeVry, HSN, Meijer, Nikon, Sony Online Entertainment, United States Air Force and the USDA. The mix of revenue across geographies for the quarter was 69% Americas, 19% EMEA and 12% Asia-Pac.

On expenses, most of my comments will be for stock-based compensation. Total gross margin was 71%. The margin on recurring revenue was 85% this quarter and professional services gross margin was 17%. Total operating expenses were $28.2 million this quarter. We reported an operating profit of $6.3 million or 13% of revenue. On the bottom line, we recorded GAAP net income of approximately $2.9 million or $0.09 per share. Excluding stock-based compensation, our non-GAAP net income was $5.1 million or $0.15 per share. Headcount at the end of the quarter was 887.

Now moving to the cash flow statement. Cash generated from operations this quarter was $6 million. Capital expenditures for the quarter were $2.8 million. We ended the quarter with total cash and investments of $109 million.

Now turning to guidance. For the fourth quarter of 2010, we expect revenue to be approximately $49.3 million. We expect non-GAAP earnings per share, which excludes stock-based compensation to be approximately $0.15 and GAAP earnings per share to be approximately $0.09.

For the full year, we're raising guidance for total revenue and earnings. We expect total revenue to be approximately $183.5 million. We are also raising our guidance for annual recurring revenue growth and expect it to be approximately 26%, which is above our previous guidance of 22%. For the full year, we expect non-GAAP earnings per share, which excludes stock-based compensation to be approximately $0.46 and GAAP earnings per share to be approximately $0.24.

We expect stock-based compensation to be approximately $2 million for Q4 and approximately $7.7 million for the year. I want to call your attention to our share count, so you can adjust your models approximately. We're now forecasting approximately 35.5 million fully diluted shares outstanding for the fourth quarter, which should also be your new baseline share count. For the full year 2010, we expect approximately 34 million fully diluted shares outstanding.

We expect capital expenditures for the year to be approximately $12 million. With respect to 2011, as you heard Greg said earlier, we are expecting to grow recurring revenue at a rate of 20% in 2011, and we expect professional services to be up about 5%. In summary, we had a great quarter and the business fundamentals are strong.

With that, I'll turn the call over to questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from David Hilal from FBR Capital Markets.

David Hilal - FBR Capital Markets & Co.

Just a question about the two large deals in the quarter, how much did they contribute to bookings? And then when you look at the past year, are you finding more and more of these large deals in your pipeline?

Greg Gianforte

These large deals as we've said really recognize the fact that we're having a transformational effect on our clients. On a specific percentage for you on the contribution, we'll say one of the deals was our first eight-figure deal in the history of the business, which I think again emphasizes the momentum we're seeing. If you look back historically here, we're seeing more and more of these larger transactions, really representing the nature of the work we're doing for our customers.

Operator

We'll take our next question coming from Keith Weiss from Morgan Stanley.

Keith Weiss - Morgan Stanley

If I'm looking at this right, with 37 months, doesn't that put your annualized contract value actually down on a year-over-year basis? And I mean, if I look at that annualized contract value on a year-to-date basis, I'm getting low- to mid-teens growth year-to-date. Can you help me understand like how that switched to 20% annualized recurring revenue growth in 2011?

Jeffrey Davison

I think your math is right. One thing I do on that calculation is Q3 last year we had a large professional services booking about 4½ back at out [ph] when you do that comparison. But moreover, the reason I gave the color on the current backlog and gave the software portion of the current backlog is bookings and the annualized contract value of bookings is not the best metric to look at as the growth of the business because it includes, as I mentioned, professional services. But as we've mentioned before, renewals, early renewals make renewals. So quarter-over-quarter, it's going to go up and down, and not really necessarily what's going on in the growth of the business. So if you go to look at current portion of the backlog, you're going to see what's being added to the business. And then I specifically gave you the software portion so that you can tie that to the recurring revenue. So if you go look at that, you're going to see on a trailing 12-month basis, it's up 23%. And it's just a better indicator of the growth in the business.

Operator

Our next question is coming from Nathan Schneiderman from Roth Capital Partners.

Goran Vasiljevic - Roth Capital Partners

This is Goran Vasiljevic for Nathan Schneiderman. My question regards to how many social deals that you have in Q3 and then if you could also tell me how many in Q2 and Q1 of this year?

Greg Gianforte

I don't have those specific numbers in front of me. I will say that we've been very, very pleased with the continued progress in the social area. I was just at our User Conference in EMEA just earlier this week and it was the topic of discussion. I had a dinner with about 10 of our larger clients there and the one thing they want to talk about is how to implement social within the business. And clearly, they're looking to us for advise and for technology on how to do that. But again, I don't have the specific numbers here in front of me.

Operator

And we'll take our next question from Laura Lederman from William Blair.

Laura Lederman - William Blair & Company L.L.C.

Can you talk a little bit about how the trailing 12 months one year software backlog is 23%, yet you expect 20% growth in recurring revenues for next year. So if you will help us understand that three-point delta, is that conservatism or do you expect things to slow a little or...

Jeffrey Davison

Well, I think when you look at the trailing 12 months from this year, you're comparing to one smaller number a year ago. So we have a more difficult comp next year. And as we look out, we want to start out especially this far up. In events of next year, no. Maybe a little bit of conservatism, we're looking at 20% at the right number.

Laura Lederman - William Blair & Company L.L.C.

During Analyst Day, the use of meeting [ph], you hiring additional people on the sell side but that will be limited from extent if I wanted to hit that 18% operating margin, leaving Q4 of next year. Can you talk about have you started hiring? Any sense of -- if you expect that to be maybe up 20%, 15% in the first half of the year? Just a little bit of color on that. And a related question, would you logically expect the recurring revenue growth to accelerate in '12 based on the hiring that you're doing in '11 and the end of this year?

Jeffrey Davison

We have started hiring. But the original point about this balance between margin expansion and top line growth. I would just say we firmly believe we can do both. And I think we've demonstrated we've been able to do both. We've seen margin expansion over this past couple of years while at the same time, we can grow on the top line and particularly in areas where we want to grow it, which was the recurring revenue. We believe that will continue. We finished Q3 at 13 points of operating margin. Our goal, as we've said, 18 points a year from now. We're on track for that. And we'll continue to hire. Historically, we tended the front end load our hiring in a year. I think that will be the case again this year. And as you see, margins tend to step back a little bit in Q1 and then improve through the course of the year. Certainly, we are investing to accelerate top line growth. And as Jeff mentioned a minute ago, the reason we wanted to give some indication in 2011 is that we're thrilled with the results we have this year. We want to set reasonable expectations for growth next year and if we can continue to grow this business at 20% or north, I'm personally very pleased with that.

Operator

And we'll take our next question coming from Tom Roderick from Stifel Nicolaus.

Tom Roderick - Stifel, Nicolaus & Co., Inc.

So in looking at the term line, it says here that 37, I understand you had one big eight-figure deal that had a longer term length. But I was wondering if you might share with us anything philosophically you've got from the salesforce level. Should we expect to see these term lengths? Could they go up from here? Will you be willing to do more four- and five-year deals if your customers asked for that or is this truly a one-time anomaly?

Greg Gianforte

Yes, I would say Tom our standard arrangement that we put on the table is a three-year agreement and that's where the center of the activity is. A five-year deal is rare. It just happened to be a big deal this past quarter. And I think the important point is here that people get really focused on term length and annualized bookings and these sorts of things. And as Jeff mentioned earlier, we're really trying to point people to a leading indicator that normalizes for the stuff that doesn't get normalized out of the bookings figure. That's why we're pointing to this current software backlog, which is probably a pure number that indicates how much stuff is booked but just not recognized yet on the P&L. And it's the best indication of how quickly the underlying recurring revenue is growing.

Jeffrey Davison

Yes, just to add, Tom. The 37 months, if you take that large deal out, the average is 32 months. So it really is one outlier deal and I don't think we expect to see that repeat, repeating that.

Operator

[Operator Instructions] We'll take our next question coming from Mark Murphy from Piper Jaffray.

Mark Murphy - Piper Jaffray Companies

I was just wondering if you could comment on the growth in the session-based revenue versus the feed-based revenue for Q3, was there maybe any Delta between the two? And then the other question, you had talked about placing a stronger emphasis on the new customer acquisition in the future. I'm just wondering if you have any thoughts on maybe when the number of active clients is going to start to lift off of this current level?

Greg Gianforte

No change in feed versus session. I mean, almost every deal we do have both feed and sessions on it. And as we talked about it at Analyst Day, it's really mobile and social that's driving interactions. It's the contact center replacements driving seats. They're both going up. In terms of customer count, I would just say that since we've been at 1,900 customers, our recurring revenues it growing 50%. So I think that it's really important as you think about the story and our approach to market, this is about quality of customers. We've essentially been upgrading our installed base where we kept further expansion opportunity. That being said, there's no question we got to grow the total number of customers, but that doesn't mean the opportunity gets bigger. We are, as we look at incremental investments in sales and marketing, there is an increased focus on new customer acquisitions. You saw it pick up a little bit this past quarter. And I would expect it to continue to go up. And as that, as we stopped retiring the lesser value customers then the total count will go up as well.

Operator

And we'll take our next question from Nathan Schneiderman from Roth Capital Partner.

Goran Vasiljevic - Roth Capital Partners

With regards to the 17 large deals, how many of them are multi-product deals?

Jeffrey Davison

Yes, so of the 17 large deals, I think virtually all of them would have multiple products on them. I think in that group, there were two, if I'm getting my numbers right, two that were new customers, 15 that were existing customers, they are kind of across all regions just to give you a little bit more color. But generally, the large deals, even the smaller deals tend to have some web self-service and aged desktops and social, some chat, they're kind of a mix bag because that's typically where we engage with clients. Particularly the larger deals, as you could tell from the numbers tend to be renewal and expansion deals and once the client relationship gets to the point works a larger deal, they tend to have implemented multiple products.

Operator

And our next question is from Tom Roderick from Stifel Nicolaus.

Tom Roderick - Stifel, Nicolaus & Co., Inc.

Jeff, I wanted to follow up on your point there regarding bookings and the term length, and it sounded like you pulled that one deal out this quarter. So the expectation would be I guess in my mind that the absolute level of bookings comes down from the third quarter level and the term length kind of goes back to that 32, 33, 34 month time frame. Is that a fair expectation? I know you don't want us to focus on that exact level of bookings but it might help there to at least get expectations aligned in the right place.

Jeffrey Davison

I'm not quite sure I understand your question, to get to the 32, you have to pull that out. You have to get indications of bookings on a go-forward?

Tom Roderick - Stifel, Nicolaus & Co., Inc.

Yes, so the question is, as we look at next quarter, is it a rational expectation to think that the absolute level of bookings is actually down from the $85 million?

Jeffrey Davison

That's entirely possible. We're not really going to get into business of forecasted of bookings though. That is one of the reasons we're kind of directing, and our focus is on recurring revenue. And so all the guidance we're giving for next quarter is growth in recurring revenue and total revenue and I think that's up by like 20% year-over-year for Q4 is what the guidance would be. So I really cannot [ph] share away from giving you any forecast on bookings.

Greg Gianforte

And I would just add, Tom, internally it's not a metric we focus on. I mean nobody's compensated on bookings. It's just an indication of total contract value, it's all it is. And for all the reasons we've talked about, it includes early renewals, it includes weight renewals, it includes a lot of stuff that is going to make that number bounce around. All the more reasons why we point to current software backlog. It's the best forward-looking indicator of organic growth for the business.

Operator

And I'm showing no further questions in the queue at the moment. I'd like to turn the conference back to your host.

Greg Gianforte

Okay, I know it's a busy afternoon. So thank you very much for joining us. Again, we're thrilled with the results in the business. And we look forward to our interactions over the coming quarter here. Thanks for joining us.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. You may now disconnect, and you have a great day.

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