Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  
TRANSCRIPT SPONSOR
Cornerstone OnDemand Logo

RightNow Technologies Inc. (RNOW)

Q4 2006 Earnings Call

January 31, 2007 4:30 pm ET

Executives

Stacie Bosinoff - IR

Susan Carstensen - CFO

Greg Gianforte - Founder and CEO

Analysts

Tom Ernst - Deutsche Bank

Jason Maynard - Credit Suisse

Laura Lederman - William Blair

Brent Thill - Citigroup

Christopher Sailer - Goldman Sachs

Tom Roderick - Thomas Weisel Partners

Nick Pajwani - Roth Capital Partners

Robert Schwartz - Jefferies

Keith Weiss - Morgan Stanley

Brendan Barnicle - Pacific Crest Securities

Phil Rowe - Prudential

James Cappello - Kern Capital

Michael Huang - ThinkEquity

Dan Cummins - Banc of America

Eric Savitz - Robert W. Baird

Raghavan Sarathy - Ferris, Baker Watts

Presentation

Operator

Good afternoon. My name is Tony and I will be your conference coordinator. This call is being recorded. At this time, I would like to welcome everyone to the RightNow Technologies' Fourth Quarter 2006 Earnings Results Conference Call. All lines have been placed on mute. After the speakers' remarks, there will be a question-and-answer period.

At this time, I would like to turn the call over to Ms. Stacie Bosinoff, Investor Relations. Please go ahead, ma'am.

Stacie Bosinoff

Good afternoon, everyone, and thank you for joining us on RightNow's fourth quarter and year-end conference call. Joining me on the call today is Founder and CEO, Greg Gianforte and Chief Financial Officer, Susan Carstensen.

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 or 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, 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, 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 an obligation to provide updates in the future. We caution you that such statements are just projections and actual events and results may differ materially from what we discuss today. Please refer to the documents we filed with the SEC, specifically our most recent annual report on Form 10-K and quarterly reports on Form 10-Q. These documents may contain and identify important factors that could cause the 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 as well as an updated investor presentation on the Investor Relations section of our website that contains historical information for easy reference.

With that, I will turn the call over to Susan.

TRANSCRIPT SPONSOR

Cornerstone OnDemand Logo

Want to understand the future of human resources software?

Cornerstone OnDemand is the leading provider of SaaS solutions for integrated talent management, covering the human capital life cycle from hire to retire.

We offer over 30,000 online training titles and performance tools for compliance and analytics to help companies maximize workforce productivity and achieve organizational excellence.

Learn about talent management and our industry leading products for learning management, corporate social networking, onboarding, compensation, compliance, employee performance management and succession planning at CornerstoneOndemand.com.

To sponsor a Seeking Alpha transcript click here.

Susan Carstensen

Thanks, Stacie. Good afternoon, everyone. Thank you for joining us. Since our final results are in line with our preliminary announcement, I will give a very quick recap of the quarter and year-end results and then get right to the change of our business model and our guidance for 2007. I will then turn the call over to Greg.

With that said, revenue in the fourth quarter was $28.8 million and $110.4 million for the year, a 27% year-over-year increase. Recurring revenue was $17.7 million and $63.4 million for the year, a 38% year-over-year increase. GAAP EPS for the quarter was a loss of $0.07 per share. Excluding stock-based compensation, non-GAAP EPS was a loss of $0.04 per share for the quarter. GAAP EPS for the year was a loss of $0.16 per share and non-GAAP EPS was a loss of $0.01, looking through approximately $41 million for the quarter and $157 million for the year, up nearly 50% year-over-year.

When you look at the full year, the bookings margin grew by 4 percentage points to 28%. Combine that with the bookings increase and the result is a 73% increase in bookings' margin dollars, which reflects the increased efficiency and leverage in the model and translate it directly into cash. Cash from operations was $4.3 million in the fourth quarter and $27 million for the year or up over 82% over last year. Mix of revenue across geographies was 74% Americas, 19% EMEA, and 7% Asia Pac.

We had three deals over 1 million this quarter and no customer accounted for more than 10% of revenue. Average deal size was approximately 164,000 compared to 211,000 in last quarter and 123,000 last year. The 33% year-over-year increase in average deal size reflects our continued success in large enterprises and the breadth of our deployments across product lines. Strong verticals this quarter were telecommunications, high-tech, financial services and the public sector.

Turning to the expense line, noting that my comments on operating expenses are before stock-based compensation, the overall gross margin was 70% for the quarter, with 94% coming from our software services and hosting and 6% from professional services. Total operating expenses were $22.1 million this quarter or 77% of revenue. Stock-based compensation for the quarter was $1.1 million which is allocated to each cost and expense line item on the P&L. Total stock-based compensation for the year was $4.6 million in line with our forecast. Headcount at the end of the year was 658, an increase year-over-year of 128 employees. And we grew headcount 24% this year, while growing booking by 50%. We are pleased with the leverage our model is providing as we scale.

Next on the balance sheet and cash flow statement. We ended the year with total cash and investment of $78.3 million. As I mentioned earlier, we generated $4.3 million in cash from operations in the quarter and $27 million for the full year, representing 25% of revenue. Deferred revenue increased by $12 million during the quarter to $114.6 million, an increase over 2005 of 69%. Current deferred revenue increased $8.3 million to finish the year at $68 million, our strongest quarterly increase all year.

Now turning to guidance in the business model. Last quarter, I detailed our plans to change some elements of the business model in order to reflect the current state of the on-demand market and to better align our financial statements with our business success. At that time, we said, we would continue to offer perpetual licenses as an option to customers. And we forecasted revenue from those licenses while continuing to decline as a percentage of revenue but stay flat in total dollars. We now know that the market is moving away from perpetual licenses, even faster than we had anticipated. We've seen it in our results and in our pipeline. To give you a good idea of how fast it is happening, compare the full year 2005 to 2006. While our bookings grew 50% and recurring revenue grew 38%, perpetual sales were flat.

The trend was particularly evident in the fourth quarter as more and more customers selected the subscription option. We believe this is a direct result in the market's accelerated adoption of on demand especially among large enterprises. As you are all aware, the perpetual mix adds an extra degree of risk and volatility to our results every quarter. Conversely, subscription revenue provides visibility, predictability, and allows for increased lifetime customer value. Therefore rather than fight the quarter-to-quarter volatility of a long transition, we have decided to jump right to the end and to eliminate perpetual revenue from the business model. We have taken perpetual licenses off our product price list. For those customers in our pipeline and our existing customers that prefer perpetual licenses, we will work to structure ratable arrangement.

The immediate impact on the P&L is significant. Our previous guidance for 2007 was for perpetual revenue of approximately $25 million. As we close those deals, we will pick up some revenue as it flows in throughout the year but given the five-year crossover point in the pricing, this adds roughly $2 million into revenue in 2007 versus the 25. The decrease in revenue essentially flows straight to the bottom line. This impacts Q1 the most but then the model immediately returns sequential revenue growth and profitability in 2008.

Additionally, as we have gotten some more customer experience with RightNow 8 and the capabilities built into the solution that were previously delivered as custom services by the Pro Services Group, I am projecting Professional Services revenue for the year of $27 million to $28 million or an increase of approximately 15% over 2006. The workspace designer and customer experienced designer allow our customers to implement greater functionality without hands-on assistance. We do pick up some cost savings on this change.

With these changes, the key metrics that drive the business are revenue, earnings and cash flow. Our success signing new customers, retaining our existing customers, and expanding those relationships will be evident in those figures. Visibility and predictability of our revenue stream will increase and earnings will be aligned with revenue.

Last, certainly not least, we believe the true sign of success in any business is the ability to generate cash. That has been a constant in our business model. And as we work through this transition in 2007, cash will be the clearest sign of success. We continue to expect to grow cash from operations approximately 30% in 2007. Many of you have asked that we provide some continued visibility on bookings especially during this transition period. The reality is that with the elimination of perpetuals, even the gross bookings number is not meaningful for year-over-year comparison. What is meaningful in comparable year-over-year is a measure of our new recurring business. The recurring revenue plus the change in net deferred revenue is a proxy for the new recurring business we are signing and billing.

We've always provided the amount of recurring revenue in our supplemental data sheet and you will now find the calculation of recurring revenue plus the change in the net deferred revenue there as well. This will provide you with a clear picture of the apples to apples growth in new recurring business over the past several years and will also be a measure you can calculate each quarter. To illustrate, in 2006, our recurring revenue plus the change in net deferred revenue was $87.6 million. In 2005, the comparable number was $54.6 million. This 60% increase reflects the growth of our billed recurring revenue base in 2006.

And with those changes applied to the model, our guidance for 2007 now calls for revenue in the range of $116 million to $120 million and a non-GAAP net loss of $12 million to $14 million or $0.36 to $0.44 per share. GAAP EPS which includes approximately $6.5 million of stock-based compensation is expected to be a loss of $0.56 to $0.64 per share. In the first quarter, revenue is anticipated to be between $24 million and $25 million. We expect first quarter non-GAAP loss per share of $0.19 to $0.21 and GAAP loss per share of $0.23 to $0.25. EPS is based on an expected share count of $32.8 million for the first quarter and $33.2 million for the year. Taxes for '07 for both the P&L and cash flow are expected to be approximately $1 million. Cash flow from operations is expected to range from $32.5 million to $37.5 million and we expect to invest between $10 million and $11 million in capital expenditures during the year.

For your models and from the guidance above, you can see we take the biggest hit to earnings in Q1 and then we expect continuous quarterly improvement in operating margins over the remainder of 2007, leading to a return to profitability in 2008. This operating leverage only increases our confidence in our objective, more than doubling the size of the business with operating margins of 15% in 2009.

So, in summary, while the short-term income statement impact is somewhat painful for all of us, these changes are unquestionably the right thing to do for the business and for our shareholders, and now is the right time to do it. We are increasing the visibility and predictability of our business, increasing the lifetime value of the customer relationship, all while expecting to grow recurring revenue by 40% and cash from operations by 30%.

I will be happy to answer your questions after Greg's remarks. But with this, I would like to turn the call over to Greg now.

Greg Gianforte

Thanks, Susan. Looking back at '06, overall we had a great year. Booking are up approximately 50% year-over-year reflecting the solid execution of our sales team and RightNow's unique value proposition. This year, we added more than 500 new customers bringing our total customer count to about 1800 worldwide. Every quarter, we've highlighted our growing success with the enterprise and the public sector. And we ended the year with nearly 60% of revenue coming from these customers. We also signed 18 deals over $1 million in 2006, by far our largest number.

And for the full year, we served up an astounding 1 billion customer interactions. We were especially happy with the performance of our newer sales, marketing, and voice solutions. In the fourth quarter, new products were more than 20% of sales and for the year, they grew more than 125%. We are seeing good opportunities for cross-selling both RightNow and sales debt solutions into our combined customer base and our voice solutions continue as a unique differentiator for us.

One customer story from the quarter that is worth sharing is Pearson Education. We set up a pilot in their Boston office and were able to immediately reduce contact center activity by 40%. Pearson Education was so impressed with what we did for them, they immediately became a reference account even before the pilot was completed. And they have already asked to sit on a customer panel so they can share the success with others.

This speaks volumes about the strong relationship we quickly forge with customers as a result of the rapid ROI we deliver. Pearson also demonstrates the growing importance of customer experience. One macro trend that is getting a lot of airplay this year is the renewed focus on the consumer. Whether it's Time Magazine naming YOU as the Person of the Year or the incredible success of the social sites like YouTube and MySpace, technology is connecting people with each other and connecting companies to their customers in far more intimate ways that were previously possible.

This trend is having a profound effect on the distribution channel, which quite frankly is collapsing. Rather than deal with middlemen, consumers are going directly to manufacturers and suppliers for support. Consumers have been empowered like never before. And for companies, this demand for a direct relationship is quite daunting. Many of the most consumer-friendly companies have never had to deal directly with their end customers and aren't very good at talking to them or listening to them. Traditional CRM has always been largely about internal processes and efficiency. Our success is driven by enabling our clients to focus externally and actually reach through the channel and deliver more personal and relevant customer experiences without driving up costs.

Customer experience is our focus in 2006 and this will continue in 2007. Our solutions enable our customers to actually talk to their customers, listen to their customers, and then respond to their needs. As proof, take a look at the awards our customers have won for outstanding experiences they are delivering using our solutions. TD Banknorth which ranked No. 1 for simplicity. Orbitz was named No. 1 for online customer respect. Overstock.com was recognized in the top five for customer service by the National Retail Federation. BT Global Services was awarded the Customer Service Innovation Award and Symantec was awarded for best practices in leveraging customer feedback.

Our message here is simple. Companies who use RightNow set the standard for great customer experience. Let's talk about 2007. 2007 is all about leveraging our investment in RightNow 8 and expanding our success. We have been using the new product internally and several customers are already live. The response we have seen from these customers, industry analysts has been really fantastic. I believe RightNow 8 is a game-changing solution. This may sound bold, but if you think about it, CRM is really broken into two camps. On one hand, you have the perception that you need in on-premise application for mission-critical deployments in order to deliver power and speed. That is how Oracle and SAP sell their vision.

On the other hand is this tremendous appeal of lower cost of ownership and flexibility that comes from on-demand. With RightNow 8, we can deliver it both. Our smart client combines the cost and employment advantages of the on-demand model with the power and speed of a desktop application. With RightNow 7, we pushed the browser to its limits and large enterprises became true believers. With RightNow 8, we eliminate any remaining barriers to mission-critical on demand deployments in large enterprises.

Our global sales team is very excited about the opportunity in front of us. We are giving them a game-changing solution to sell and they have the industry's most referenceable customer base to help drive their success. While the changes in our financial model are the right thing to do for the business, they in no way change how we interact with customers or the value that we create for them. This means we are in a better place than ever, and deliver solutions in line with our vision of better customer experiences at a lower operating cost.

In summary, our focus for 2007 is simple. One, we have aligned our financial model with the accelerating market adoption of on demand. Two, we are continuing to penetrate large enterprises and expand within our install bases. And three, we are leveraging our investment in RightNow 8 to show our customers how to drive success by connecting directly with consumers. With that, I'd be happy to open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. Today's question-and-answer session is held electronically. (Operator Instructions). And we will take our first question from Tom Ernst at Deutsche Bank.

Tom Ernst - Deutsche Bank

Good afternoon and thank you. So, I guess we are going to have to find new things to talk about. We seem to have spent half our time on the perpetual subscription mix and I guess it will be refreshing looking forward. Let me start with that. Looking -- you mentioned the product, Greg, in terms of several customers going live on it. Is there some significant changes to the UIs enhancements there? I am wondering if you can give us any specifics. What are you finding, both from the user community and from the administrators? Is some of the early response positive and negative you might be getting?

Greg Gianforte

Yeah. Thanks, Tom. The primary comment we are getting is, boy, our users already know how to use this. The UI was designed for speed and power. And because of the smart client technology, everyone out there already knows how to use Outlook. So, the training time has been significantly reduced. A number of customers have commented, boy, this is one of the smoothest upgrades we've seen. So that's all been positive.

Tom Ernst - Deutsche Bank

What about comments from the administrators? Are you finding any complaints about time to deploy, time to manage?

Greg Gianforte

We have been live about a month internally and we have got hundreds of people in the sales organization and across the support organization and across the business. And the general consensus in this, what we're calling our internal trial was it has been one of the smoothest rollouts we have ever had. We tweaked it quite a bit. I mean there were quite a bit of customizations. So, it has been positive. I've been encouraged.

Tom Ernst - Deutsche Bank

Okay. If you will permit one final question, just shifting gears. Great growth last year. It has been continuing on the recurring side of the business in particular, and then the guidance includes some very strong growth. But you've been exchanging some of the people out in the field right at the top in particular, in sales. Do you feel comfortable that we don't have some execution risks during the transition of the sales organization?

Greg Gianforte

Well, that's a good question, Tom. We have been growing this business 40% to 50% for as long as I can remember. And as we continue to make these -- as we continue to grow the business and you saw the guidance for next year, for this year, we need to know we have the right maturity level and skill level at every level in the organization. The next stage for us in terms of our vision is, how do we take this business from $100 million to $1 billion in revenue. We've got to have the right people in place. It is critical for us that we pushed decision-making out away from headquarters into the field close to where the customers are. In particular that meant putting a General Manager in Europe to run Europe, to move our very successful public sector business, to put a person on the ground in Washington, DC. I personally think that has been an issue that we needed to address to continue to grow that business. So, I think we have a much stronger team today than we did 6 months ago. And honestly, I hope to have a much stronger team 6 months from now.

Tom Ernst - Deutsche Bank

Great. Thank you again.

Operator

And next to Jason Maynard at Credit Suisse.

Jason Maynard - Credit Suisse

Hey, guys. Good afternoon.

Susan Carstensen

Hello.

Jason Maynard - Credit Suisse

Just one question. I understand obviously the move to appear subscription model, can you maybe talk a little bit about how this impacts your inclination to actually offer on premise deployments? And just what percentage of your customers are actually still deploying the software on their own site?

Greg Gianforte

Yeah. So, in answer to that question, we have always separated how we contract for it from how we deliver it. There is a minority of customers who still want on-premise. We are continuing to offer that. It's really independent of the contract type. To answer your question specifically, about 10% are on premise at this point and honestly a portion of that is concentrated in the public sector. I think they've been a little slower to adopt the on demand model, the hosted delivery model, but I think it is coming.

Jason Maynard - Credit Suisse

Is that 10% of new business like in Q4 or is it just 10% of itself?

Greg Gianforte

No. Significantly less than that for new business. That is 10% of our entire install base.

Jason Maynard - Credit Suisse

Okay. And then CapEx I think you are talking about spending $10 million to $11 million. That's up a little bit from last year. I mean just is -- this a reflection of just the growth or is there anything additional that's going on the CapEx line?

Susan Carstensen

No. It really is just normal infrastructure, kind of headcount-related. Capacity increases for hosting.

Jason Maynard - Credit Suisse

Okay. That's all I had. Congrats on making the move. I think it is the right decision.

Susan Carstensen

Thank you.

Operator

And next to Laura Lederman at William Blair.

Laura Lederman - William Blair

Yeah. I think it's the right move as well, but a few quick questions. One is, following up on your thought about the public sector and how they are slow to do things. It seems so that's been a base that wants to buy perpetual. What's the reaction so far been from the government space? And the second one is the turn in of the sales force. Has the turn slowed down? What are your thoughts on that? Thank you.

Greg Gianforte

Thanks, Laura. In the question of public sector, there are certain business things that push people to a perpetual and one of the primary ones is price certainty. Under a ratable model, there are other ways to address that particular business issue around length of term, renewal options and these sorts of things. And where we have customers that have previously purchased perpetuals, we are going to find a way to work with them. But as we look through our pipeline, there is just not -- there's a continuing diminished requirement for these perpetuals and we really believe this is the right move at this time given the market demand.

Laura Lederman - William Blair

And what about the sales trend that had picked up? What's that doing now? How's hiring going?

Greg Gianforte

I think we are on track. I mean we feel comfortable with the staff we have onboard and we don't see an issue there.

Laura Lederman - William Blair

And finally on a totally different subject, in terms of competition, can you talk about what you are seeing in knowledge-based sales force automation, marketing automation, just sort of a real quick update on competition, the same, easier, harder, etc.?

Greg Gianforte

Yeah. I would say, I don't think we have seen much change. I mean it's -- actually I would say, we haven't seen any change. Basically the environment is pretty similar. I could go on for a while but there's really nothing new to report.

Laura Lederman - William Blair

Thank you.

Operator

And we go next to Brent Thill at Citigroup.

Brent Thill - Citigroup

Thanks. Good afternoon. Any changes for your long-term view now on the pure sub model that may impact some of the longer-term targets that you've set?

Susan Carstensen

I'm sorry, Brent, what do you mean?

Brent Thill - Citigroup

Just in terms of how you look at the economics of the long-term model. Does this change your view in terms of where you think the op margins or any other characteristics in the model that you have been guiding to in the past? Does that change any of the longer-terms views?

Susan Carstensen

From a real long-term perspective, we think it improve margins, it improves the model. We think this is the way to really maximize the lifetime value of the customer and that flows through revenues to margins and cash. So, we think it is better.

Brent Thill - Citigroup

Okay and Greg, a follow-up on RightNow 8. Where do you see the biggest cross-sell opportunity for 8? Where is the sales force the most excited to bring this in? Where do you think the biggest opportunity is to open up?

Greg Gianforte

Yeah. Okay. Thanks, Brent. First I want to say that this is an off summer release and I haven't publicly commented development and product management organization here but they worked incredibly hard to produce this product and they did a terrific job. I think going back to your question, I'd say that, this allows us -- as I had mentioned in my comments to deploy more mission-critical implementations, where clients, many of them had adopted broad call summer solutions. This will make it easier for them to make that transition. The addition of RightNow feedback as a mechanism for doing enterprise feedback management and integrating that into your overall customer experience which is really critical. It's another area for growth. So, it's just -- it's bringing the prices together again to help company deal with this problem of delivering better customer experiences at lower cost and it's just consisted with this overall message.

Brent Thill - Citigroup

Thanks.

Operator

And next to Christopher Sailer at Goldman Sachs.

Christopher Sailer - Goldman Sachs

Great. Thanks, guys. Greg, I guess the first -- is there any pent-up demand do you think right now for RightNow 8 and maybe did that contribute at all to some of the maybe relative weakness in the December quarter?

Greg Gianforte

Well, I look back at Q4, $41 million in bookings. A year ago we said to everybody, we are going to grow bookings 40% to 50%, and we ended up coming in at the high end of that range. So, I don't see Q4 as weak in any way. In fact, it was our second largest bookings quarter in history. Second, only to Q3 where we had extra surge from the public sector. So, pent-up demand. One of the beauties of the software service model is that customers sign up for a service and we were very, very affective selling the 7.x release. 8.0 is going to help us in sales engagements, but I don't -- it's not like pent-up demand. People want to get their hands on it but we didn't lose any business in Q4 because we didn't have 8.

Christopher Sailer - Goldman Sachs

Alright. And I guess Susan for you. In terms of the shift in the business model you obviously get a little bit less upfront not selling the perpetual. Does that change how you think about managing expenses and I guess maybe more so to what sort of growth plan do you have in terms of hiring, etc., for next year?

Susan Carstensen

Yeah. I'm happy to kind of walk through the cash. I mean obviously there was a slight impact on the cash guidance, given the switch from the perpetual to the subscription deals. But there's really three factors that drive the guidance for '07 and the 30% growth. The cash growth has been a constant driver in our business and all the old incentives are aligned and we are seeing some good productivity and efficiencies as we scale. As evidenced from last year, we grew bookings 50% while growing headcount 24%. We expect to continue to invest part of the focus, though, on revenue and earnings. Does mean our managers need to be very focused on expenses. The model changes impact earnings, which means we look at budgets and expenses and is passed our team with driving the return of profitability without impacting the revenue growth objective.

Christopher Sailer - Goldman Sachs

So I guess -- does that mean that, have you scaled back some of your growth plans or are you still planning to invest as much as you were before the business model change?

Susan Carstensen

We haven't scaled back the growth plans. I mean the opportunity in front of us to grow the recurring revenue 40% in cash doesn't lead us to a conclusion that says we would reduce expenditures.

Christopher Sailer - Goldman Sachs

And are there any changes to how sales people are going to be compensated? Maybe just talk directionally about what the shift away from perpetual, how that might impact compensation for some of the sales people?

Greg Gianforte

Sure. I'm glad you asked the question, because there's been quite a few rumors, an amazing amount of speculation about our comp plan. And as we said in the last call last fall, the comp plan we rolled out earlier this month pays our reps the same or more under the new comp plan than the old comp plan. There was some speculation that we were going to cut payouts by 75% to our reps this year and if we had done that, we wouldn't have any reps working for us anymore. I mean it's such a ludicrous idea. So, the focus in terms of the new plan is really on recurring revenue in cash. And what we've done is, we've aligned the incentives and earning potential of the reps exactly in line with the overall corporate objectives. And this is part of the conflict we have seen in the past with our focus on bookings and not having it show up in the financial results of the business. The underlying fundamentals are very strong and now we have gotten them aligned up and down the line.

Christopher Sailer - Goldman Sachs

Great. Thanks very much.

Operator

And we will do next to Tom Roderick with Thomas Weisel Partners.

Tom Roderick - Thomas Weisel Partners

Hi, guys. Good afternoon and thanks a lot. Greg, I was hoping if you could just clarify one thing. Your comments say you are essentially eliminating perpetual revenue from the business plan and taking it off the price sheet. You do indicate that there's a couple of million dollars that you will see this year from it. In the instance that a customer really wants to go in this direction and while it may be a one-off and it is not on the price sheet, will you grant specific customers the ability to go perpetual? Or is it just a flat-out done with and the couple of million we will see is a reflection of deals that were already done this year?

Susan Carstensen

Yes. Tom, let me walk through that a little bit. We had forecast $25 million in perpetual license revenue. We are not indicating that business goes away or that it necessarily reduces to a $2 million perpetual number. It's that that $25 million of business, given kind of the crossed over point, I mean those become smaller subscription deals with a much smaller '07 revenue impact. And then on the second piece of the question, when you say essentially eliminating, we are taking it off the price list. We are -- we do have an exception for customers in the current pipeline and customers who have previously bought that way. So, existing customer relationship. But even on those transactions, we are working to structure them, so they are accounted for ratably.

Tom Roderick - Thomas Weisel Partners

Okay. Thanks, Susan. Turning attention here to RightNow 8, you have got a couple of customers that are now live. Is the product generally available yet today? Or if not when should we expect to see general availability? And then as far as additional releases, when will the product be available in other geographies like Europe?

Greg Gianforte

Okay. So, we are still on track for general availability in February. The customers we have live now and there's a handful of them and we are putting more live every week, is really our final check on it. But we are still looking at general availability in February and that's really what we thought we'd do back in Q4. So, right on schedule there. The language support comes in the first point release which is due out before the middle of the year.

Tom Roderick - Thomas Weisel Partners

Okay, fantastic. That's great. Thanks much.

Greg Gianforte

Yeah.

Operator

And next to Nick Pajwani with Roth Capital Partners.

Nick Pajwani - Roth Capital Partners

Thanks. Could you talk a little bit about -- I know you touched upon the hiring plans but could you talk about plans across geographies as to where you plan to hire U.S., APAC and Europe? Thanks.

Susan Carstensen

In total for the year, I guess one way to look at it is, we are planning from a cash spend perspective about a 25% increase on the sales and marketing side. The sales and marketing teams really are located, as Greg indicated, in the customer facing jurisdiction. We have opened up an office in DC, and have a presence there that grows. We have a growing presence, an existing presence in Europe as well as mainland Europe, Tokyo, Asia Pac, Australia. It is really all our different geographies.

Nick Pajwani - Roth Capital Partners

Okay. Thanks.

Greg Gianforte

Yeah.

Operator

And next to Robert Schwartz with Jefferies.

Robert Schwartz - Jefferies

Thanks. Susan, I wanted a couple of clarifications if I may? If I hear you correctly, what you're saying is that $25 million if I were to assume that it was to come in to you but come in as a recurring revenue the equivalent would be about $2 million of revenue on your income statement. Is that what you are saying?

Susan Carstensen

Yes. The 25 had been upfront recognition but instead, if you think of a kind of pricing crossover point of 5 years you get one-fifth of that and then, given that it comes in ratably over the course of the year, you end up with roughly $2 million.

Robert Schwartz - Jefferies

Will there be any perpetual licenses? But you are not saying that you expect $2 million of perpetual licenses to be signed?

Susan Carstensen

Correct.

Robert Schwartz - Jefferies

Okay. Will there be perpetual licenses signed in Q1?

Susan Carstensen

Existing, it was in the pipeline of which is in a much smaller number. As I said, the trend keeps going down. As we look at the pipeline, there could be a handful of deals. Should be -- we will work to structure them on a ratable basis but that trend is just dropping so fast.

Robert Schwartz - Jefferies

Okay. When you give the guidance for cash flow, it was pretty close to where we had been looking. I'm wondering what you were thinking about cash flow prior to this change eliminating the perpetuals? And why does it seem to be so high given the perpetuals tended to give you more cash upfront?

Susan Carstensen

Yeah. I'm happy to walk through that. The reality is that the cash flow did come down a bit. If you think about it, the midpoint of our guidance for '06 was higher than what we came in at. So, we have some carryover from '06 into '07. So, it's 30% growth albeit on a slightly smaller number. But there is that function, there is, as Greg mentioned, all of the incentives are aligned in the business on this recurring revenue, as well as cash, we believe has an impact. And then third, while it's difficult to see in the near-term income statement model, we do see good productivity and efficiency in the business as we are scaling.

Robert Schwartz - Jefferies

And my last question, I am planning off to somebody else. You say you expect to see a return to profitability in '08. Are you talking about Q1 of '08 or can you give us more granularity on that or by the end of '08?

Susan Carstensen

Yeah. As you look at it, you can tell we take the biggest hit in Q1 of '07 and then you get really good quarter-to-quarter improvements in the revenue, as well as in the margins. We've talked about our longer-term model in '09 and more than doubling the size of the business in 15% margins. And so, it should be very respectable margins in '08. And our trajectory is early in the year.

Robert Schwartz - Jefferies

Early in '08?

Susan Carstensen

Earlier in '08.

Robert Schwartz - Jefferies

In terms of turning profitable?

Susan Carstensen

Yeah.

Robert Schwartz - Jefferies

Okay. Thank you.

Operator

And next to Keith Weiss at Morgan Stanley.

Keith Weiss - Morgan Stanley

Thank you, guys. I was wondering if you could just touch a little bit on Salesnet and whether just for 2006 whether they hit your -- the goal that you guys laid out for them when you did the acquisition? And also if you can update on how the integration of that functionality is going into the core RightNow product set?

Greg Gianforte

Right. And I'm happy to handle that, Keith. Keith, if you remember, we've done two acquisitions now with the Convergent Voice and Salesnet over the last couple of years. I think in both cases, we've executed very well. Would say Salesnet in total for the year exceeded our original plan. We had a particularly strong fourth quarter with the Salesnet sales. And Voice continues to contribute more and more. Those -- some of the business from those new products as I mentioned, up 125% year-over-year. The work is continuing to integrate them. As we have said before, it would be in the next release after 8, although we have done some preliminary integrations in the current version, the full integration will happen in a subsequent release but it hasn't slowed down the sales at all and we are very pleased with the results.

Keith Weiss - Morgan Stanley

Excellent.

Operator

And we do ask in the interest of time that you please limit yourself to two questions. We move next to Brendan Barnicle at Pacific Crest Securities.

Brendan Barnicle - Pacific Crest Securities

Thank you. Susan, I was looking at sort of how we are modeling our perpetual -- rather our term life and subscription piece going forward. And it looks like based on the Q1 guidance, there is a bit of a sequential increase going into Q1. But then really sort of ramps as we head through the year. Can you give us any more sense in terms of what that linearity is going to look like in that ramp or how that should come in through the year?

Susan Carstensen

We definitely see a quarter-to-quarter sequential increase in that. Don't know that there's anything particularly unique about the linearity.

Brendan Barnicle - Pacific Crest Securities

Okay. So we should just sort of model just a kind of straight line of sequential improvement? No seasonality or anything to reflect in there?

Susan Carstensen

No. I think -- yes. As we look at the last two years, obviously Q3 ends up being pretty strong force.

Brendan Barnicle - Pacific Crest Securities

Okay.

Susan Carstensen

It's kind of the only piece.

Brendan Barnicle - Pacific Crest Securities

Okay. Great. And then following up on the Q3 thing. Federal government, I was wondering if you had seen any change there. There have been some weakness in some areas in the Federal government. Did you see any changes in Federal government buying behavior in Q4?

Greg Gianforte

I would say, we had a strong Q4 in the public sector. It's in part because we had such a good strong base there. I mean we are essentially in every executive capital agency now in the Federal government as well as many DoD departments. And so that good strong base and reference selling is working really well. And now with a direct office there and a strong presence, which we've never had physically in DC before, I think that will allow us to continue the growth we have seen in the past.

Brendan Barnicle - Pacific Crest Securities

Great. Thanks. And I appreciate the move away from the perpetual.

Susan Carstensen

Thanks.

Operator

And next to John McPeake at Prudential.

Phil Rowe - Prudential

This is Phil Rowe for John. As we look at Q1 with the big change there, how should we think about gross margin? Will that come down for Q1 and how does it go through the year?

Susan Carstensen

Yeah. Essentially all of the margins go down. So, the gross margin goes down as well as the operating margin. You can tell from the EPS guidance. It's 28% negative gross margin or something like that and then you really see immediate sequential improvements in gross margin throughout the year.

Phil Rowe - Prudential

Okay. There was a -- what was the change in gross margin? 28%?

Susan Carstensen

It was a negative 28 -- roughly negative 28% in Q1.

Phil Rowe - Prudential

On the dollars?

Susan Carstensen

Right.

Phil Rowe - Prudential

Gross profit dollars? Okay.

Susan Carstensen

No. On just the operating margin. The gross margin just proportionately goes down.

Phil Rowe - Prudential

I see. Okay.

Susan Carstensen

Yeah. Proportionately it goes down.

Phil Rowe - Prudential

Okay. And will there be a change in the mix of deferred? Will you have more long-term deferred or will it be about 60% short-term and 40% long-term deferred going forward?

Susan Carstensen

If you recall, one of the changes we discussed on the last call is that the monthly pay yield will no longer show up in either current or non-current deferred. And so what we will continue to add to the deferred revenue are essentially the two-year -- our predominant contract term still is and has always been two-year contract paid upfront. And so those pieces will continue to increase current and non-current. And I would expect current will go up more than non.

Phil Rowe - Prudential

Hey, great. Thank you.

Operator

And next to James Cappello with Kern Capital.

James Cappello - Kern Capital

Hi. Good afternoon. What was the perpetual number for the quarter, for the December quarter? I missed it.

Susan Carstensen

Hold on, just one sec. It was 12% of bookings and the actual number and it is on that supplemental data sheet on the website but it is 4.879.

James Cappello - Kern Capital

4.879 of revenue?

Susan Carstensen

Dollars. $4,879,000.

James Cappello - Kern Capital

Okay. And that was in revenue not the bookings number? Right?

Susan Carstensen

Right. That's essentially the same number. It goes into bookings --

James Cappello - Kern Capital

Okay. Where does that take it for the year, for '06?

Susan Carstensen

22,000,809. Essentially flat with 2005.

James Cappello - Kern Capital

Okay. And in terms of perpetual going forward, you would expect perpetual to be a few million in '07, yet you are the peeling off -- what are you peeling off? $25 million or from first call you are peeling off around $24.5 million from the first call estimate for '07?

Susan Carstensen

Previous guidance that included approximately $25 million of perpetual revenue and as we see that business coming in, in the form of subscription or ratable revenue, and we take 25 out, we add $2 million back in. There is also a smaller impact that I discussed on the Professional Services line. As we built certain capabilities into the product via the workspace designer, customer experience designer, I'm projecting a slightly less increase in the Professional Services revenue than I had done before. That takes about $2 million out.

James Cappello - Kern Capital

Okay. It just seems that you are taking out a little bit more revenue than I would have thought. Is this a move towards being very conservative at this point? Or -- because you saw the trend happening, that perpetual was going down. So, I am just trying to reconcile why it takes so much of the revenue stream out?

Susan Carstensen

We had seen the trend of perpetual is going down as a percentage of bookings for the last seven quarters or so. In the fourth quarter, though, it dropped all the way down to about 12% of bookings. And as we looked at the pipeline, looked at the forecast, what we had thought was kind of a flat revenue line as opposed to this rapid decline is what changed. And so rather than dealing with the quarter-to-quarter volatility of it, we are eliminating that volatility by the model by taking the perpetual revenue out. We think the business comes back in but in the form of ratable arrangements, so the revenue impact is much smaller in '07 and then it carries forward in '08, '09, '10.

James Cappello - Kern Capital

Okay. In prior discussions around the revenue model, was that the customer would sometimes want the -- who want's the perpetuals? So, that's why you kept it as an option but have you had any pushback in the last month or so?

Greg Gianforte

And I would say that you are absolutely right. We'd spoken before about the clear need for us to provide choice to customers so they can buy the way they want to buy. The reality is as Susan said, the customers have made a choice and they've said they want to buy subscription agreements. And we are going to -- essentially we are adopting that decision and in the process provide a lot more predictability in our financial result.

James Cappello - Kern Capital

Okay. Thank you.

Operator

And next to Michael Huang at Think Equity.

Michael Huang - ThinkEquity

Yeah. Thank you very much. In terms of your guidance for the year, can you comment on how -- can you comment on your assumptions around RightNow 8 and which type of customer it actually helps target? And does it help influence the win rates in '07 and does it impact ASP and does it accelerate crossover activity? Thank you.

Greg Gianforte

Yeah. So -- thanks, Michael. Right now, as I said, I really think it changes the game. It provides for helping companies improve this external view towards customer experience. I would say that RightNow 7 did and a great job in the call center and with the e-service more of in a traditional CRM context. RightNow 8 is our customer experience release. It's the first step down a long road to help companies deal with this macro trend that's going on in the marketplace. Do I know exactly how much that is going to accelerate our business? I don't. We need to get our feet wet with a few more sales cycles and things. The early signs are very positive and I am encouraged by it. I think it's going to provide a very positive impact on the business. In part, it gives us some of the confidence we need to project 40% increasing recurring revenues this year and a 30% increase in cash from operations. So that's just some of the color on it. We will know more as these quarters go forward and you'll see it in the results.

Michael Huang - ThinkEquity

So it's fair to say that in terms of your assumptions around RightNow 8 that they are fairly conservative but they actually could be -- certainly be coming in much more positive than what you are modeling right now?

Greg Gianforte

You are doing a lot of reading between the lines. I think that we are very excited about RightNow 8. We have been encouraged by what we have seen in the marketplace. We know it's going to -- what we've seen support the trend increase in recurring revenue at this point. We are not in the position to project or say that's conservative. We have been very straight all along I think, let's say, call it the way we see it. People don't always agree. And I go back to our 40% to 50% growth a year ago, following that now at 40% increase current revenue this year. We know we can deliver that based on what we do today.

Michael Huang - ThinkEquity

Great and last question for you. Have you guys had your sales kickoff yet and if so, could you share the major takeaways that came out of that event?

Greg Gianforte

I'm glad you asked about that. We did it the first week of January. So, we are out of the blocks immediately. Response was great. We had our worldwide sales team together. Jay Rising, in particular, did a great job in organizing that. And hats off to him for coming up to speed as quickly as he did, turning in $41 million of bookings in Q4 and then launching us in this year and getting everybody down to business by the second week of January was really important. It was a very encouraging conference. So, positive.

Michael Huang - ThinkEquity

Thank you very much.

Operator

And next to Dan Cummins at Banc of America.

Dan Cummins - Banc of America

Thank you. Couple of quick questions. Is there any -- well, you said there was a change in the cash flow projection. I missed what that was, but I was curious if you could just help us with the major components of the cash flow projection in terms of, let's say, taxable pro forma operating income on the income statement? The contribution from AR collections that are going to wrap over from last year and the change in deferred? That would be my first question.

Susan Carstensen

You are exactly right. Those are the components on the cash flow. Obviously, it will start with, from a kind of non-GAAP perspective on a negative side on the earnings. Add that the depreciation. We should have some better than expected or better than last year collections on the accounts receivable because of the carryover from '06.

Dan Cummins - Banc of America

Yeah. The AR consumed a lot of cash last year. Is that right?

Susan Carstensen

Right.

Dan Cummins - Banc of America

Yeah.

Susan Carstensen

So, we expect to bring that down a bit. I have to say I'm kind of excited because, it sounds funny, we've never had a good kind of DSO calculation we have been able to talk about before. And when I look at the historical numbers and my projections going forward, if you think about that, net recurring business which is that recurring revenue plus change in that deferred, that is kind of proxy for the new business sign and build.

Dan Cummins - Banc of America

Okay.

Susan Carstensen

That divided by 90 days into a receivables number actually should help everyone with their modeling around that, and gauging our cash collection. Also depending on your estimates around that, it's what drives the recurring revenue, but it's also what drives the increase in the net deferred revenue that gets you there on the cash flow.

Dan Cummins - Banc of America

Okay and then just a quick question for Greg around the customer additions. I was curious if you felt there was any distraction to the business in the fourth quarter? And what are RightNow's customers add goals looking forward here? And I was just curious if the changeover in accounting reflects any assumptions that there will be some turnover in customer base?

Greg Gianforte

I think that on the customer ads, we have got more focus this year than we have ever had before in terms of the target clients we are going after. We are pleased with the ads. I mean the size of the companies we are signing continues to go up as we mentioned in the large enterprise, that we continue to see that in Q4. So, I was pleased with the ads in Q4. And it's a pretty clear focus for the team. So, I'm not sure what else I can add to that exactly in terms of customer acquisition, the focus on customer experience and finding new organizations that have millions of clients themselves. We need to deal with this big shift is really where the focus is.

Dan Cummins - Banc of America

Okay and how about the changeover? Any turnover in terms of the base? Anybody just not okay with software service instead of licensed software?

Greg Gianforte

Yeah. So that's a total non-issue. The reality is, our clients for a while have been expecting subscription contracts from us and we have been presenting a term contract. It doesn't change in any way how much they pay us or when they pay us, this shift from term to subscription. And now the contract we are presenting to them is actually what they expect. So, that has had no impact whatsoever. In fact, if anything it will probably shorten sales cycles although we haven't been through enough yet to know.

Dan Cummins - Banc of America

Thank you.

Operator

And next to Eric Savitz at Robert W. Baird.

Eric Savitz - Robert W. Baird

Thanks. Susan, I was hoping that maybe you could give us the actual contribution from Salesnet in 2006? It sounds like it performed kind of exceed your expectations as well as in '07 kind of what you are expecting in your guidance from Salesnet?

Susan Carstensen

I'm sorry, Eric, we aren't going to break out the Salesnet numbers alone.

Eric Savitz - Robert W. Baird

I mean kind of is there any sense in terms of how much it exceeds expectations by? I'm just trying to get some sense of materiality from that?

Susan Carstensen

I really can't break out the individual pieces. The fact that the Salesnet, the Marketing and the Voice grew 125% this year was great. It did exceed our expectations. We've done the analysis before we did the acquisition in terms of the payback. It's exceeding our expectations. That's as far as I can go.

Eric Savitz - Robert W. Baird

Alright. What -- can we assume going forward that you are pleased with the use of cash and that's something we can kind of look forward in the future and see you doing some more of those acquisitions as they come up?

Greg Gianforte

No. I would say that we do have a very specific M&A strategy around the road map that we built for customer experience. I think that it's important for any growth company to have inorganic growth as a component of the overall strategy. I feel pretty good. We've got two under our belt now and both have returned positive returns for shareholders. So, we are going to be prudent about it. We've got -- we have a base business that's growing 40% projected this next year, recurring revenue. There's no reason to bet the farm. But as opportunities present themselves and they are aligned with our overall solution road map, we're going to take a hard look at them.

Eric Savitz - Robert W. Baird

Great. thanks a lot.

Operator

And our final question will come from Raghavan Sarathy at Ferris, Baker Watts.

Raghavan Sarathy - Ferris, Baker Watts

Thank you. Could you give us a further clearing sales headcount, as of fourth quarter? And then what do you expect that to end in 2007?

Greg Gianforte

Sure. That's a fair question but as we mentioned in the last quarter, we are a lot more focused now on the total spent in sales and marketing given the shifts that we have done with manager to rep ratios and sales consultants. We've been changing the mix there just to lead to better lead generation and better management. So, the number of reps is not something we are going to be disclosing because we don't think it is relevant. I think that the important metric is that, as Susan had mentioned, we are increasing the cash spend on sales and marketing about 25% this year and we think that is the appropriate spend to get our '07 results and lay the groundwork for '08.

Raghavan Sarathy - Ferris, Baker Watts

Alright. In terms of the monthly bookings, it used to be about 25% of your total bookings. Was there any change in that last year? And what is your expectation for '07?

Susan Carstensen

No. In '06 really both fourth quarter and throughout the year, it's ranged between 20% and 25% and I think that's a reasonable expectation for '07.

Raghavan Sarathy - Ferris, Baker Watts

Okay. And Susan, can you give us some sense for your expectation for R&D and G&A? You talked about 25% increased sales and marketing. How is that?

Susan Carstensen

I don't have that percentage increase or -- in front of me right now. There's certainly increased spend on R&D from '06 to '07 in line with FASB and others. They are getting done with our RightNow 8 and they are heading off on RightNow 9 and some nominal increase on the G&A side, as well as we continue to sign more customers and send out process more transactions. I don't have the relative percentages. We are investing and in absolute dollars, we are investing in every line item.

Operator

Well, this does conclude the time that we have allotted for questions today. I would like to turn the conference back for any closing or additional comments.

Greg Gianforte

Okay, great. Again, I will just close by saying I appreciate your time with us. We are pleased with the results in '06 and we are looking forward to a great '07 and, again, unquestionably this change in the financial model is the right decision and it lays the groundwork for us to continue to scale this business. So, thank you.

Operator

This does conclude today's conference. We do thank you for your participation. You may disconnect at this time.

TRANSCRIPT SPONSOR

Cornerstone OnDemand Logo

Want to understand the future of human resources software?

Cornerstone OnDemand is the leading provider of SaaS solutions for integrated talent management, covering the human capital life cycle from hire to retire.

We offer over 30,000 online training titles and performance tools for compliance and analytics to help companies maximize workforce productivity and achieve organizational excellence.

Learn about talent management and our industry leading products for learning management, corporate social networking, onboarding, compensation, compliance, employee performance management and succession planning at CornerstoneOndemand.com.

To sponsor a Seeking Alpha transcript click here.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: RightNow Technologies Q4 2006 Earnings Call Transcript
This Transcript
All Transcripts