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Executives

Bobby Yazdani - Founder, Chairman, Chief Executive Officer and President

Roy Lobo - Investor Relations

William Slater - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Scott Berg - Feltl and Company, Inc.

Ryan Bergan -

Kevin Liu - B. Riley & Co., LLC

Saba Software (OTCPK:SABA) Q3 2011 Earnings Call March 24, 2011 5:00 PM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Saba Third Quarter Fiscal Year 2011 Earnings Call. [Operator Instructions] I would now like to turn the call over to your host, VP of Investor Relations, Roy Lobo. Please go ahead.

Roy Lobo

Good afternoon, everyone. Welcome and thank you for attending Saba Software Third Quarter Fiscal Year 2011 Conference Call. With me on the call today are Chairman and Chief Executive Officer, Bobby Yazdani; and Chief Financial Officer, Bill Slater. If you have not received today's earnings release, you may download a copy of this press release from our website at

investor.saba.com. There you will also find income statement and balance sheet tables for fiscal year '10 and the first three quarters of fiscal year 2011.

Before I turn the call over to our executives, I would like to remind everyone that during the course of this conference call, we will be making forward-looking statements regarding our business outlook, future performance and expectations for future events. These statements are based solely on information available to us today and are subject to risks and uncertainties. For information concerning factors that could cause actual results to differ materially from those in the forward-looking statements, we encourage you to review our annual report on Form 10-K for the year ended May 31, 2010, and subsequent Saba periodic reports, which are available through the Investor Relations section of our website or through the SEC's website at sec.gov. We assume no duty or obligation to publicly update or revise any forward-looking statements. In addition, we intend to discuss both GAAP and non-GAAP financial measures during this call. A reconciliation of GAAP to non-GAAP financial results is included with these financial statements accompanying our earnings release. With that I would now like to turn the call over to Bobby Yazdani, our Chairman and CEO.

Bobby Yazdani

Thank you, Roy. Good afternoon, everyone. I'm excited to report that we had a strong quarter, while Saba People Cloud offering is gaining mind share with customers in the mid-market, enterprise and the public sector. Our top four deals in the quarter were also on our Saba People Cloud offering. We also have a number of our existing large enterprise customers who initially purchased our software behind the firewall and are now communicating their interest to move their applications over to the Saba People Cloud.

Our employees, our customers and our partners are embracing our strategy. We are successfully accelerating our business to the cloud, delivering record results and generating cash. We achieved record ACD bookings this quarter of $37.1 million, up 15% year-over-year. That is annual contract value, not total contract value. These are a fourfold increase in the number of new SaaS transactions of over $50,000 and our annual contract value for new SaaS bookings increased 351% on a year-over-year basis.

Our SaaS revenues are also being positively impacted. Our year-over-year growth rate for our SaaS revenue grew nicely and doubled sequentially. We signed 41 new customers in the quarter with nine of our 12 largest deals in the quarter being for our Saba People Cloud offering. We added such names as John Deere, Eli Lilly, Bloomberg Financial and TeleTech Holdings to name a few. But the more exciting news to us beyond these more key customer names is how these customers are expanding the use of our solutions beyond the traditional ways. Whereas once our solutions were used primarily for compliance training, they are now being expanded to also be used for sales enablement, new products introductions, business transformation and new market expansions.

Our solutions were not only being deployed to the employee base, they are now being expanded to the extended enterprise. And recently, we have seen a number of our customers expand beyond their extended enterprise to reach their customers and end users. This is big news for us. Our ability to continuously innovate and promote users of our applications beyond the traditional boundaries has positive implications for Saba. The growth opportunity ahead of us looks very promising. We will continue to innovate and leverage the knowledge and expertise we gained from serving our large global enterprise customers to serve our customers on the market in new, nontraditional ways.

Let me shift gears to update you on our three-pronged strategy at Saba that focuses on growth, product innovation and building an inspiring company and bank. While we have talked a little bit about our growth opportunity, we have a number of additional growth prospects. We have now a dedicated mid-market sales team whose sole focus is to sell our Saba People Cloud offering to organizations between 2,000 and 7,000 employees. We have a dedicated client executive team who's also responsible to upsell and cross-sell our unified cloud applications to our existing customers.

On the international front, Asia Pacific and Latin America continue to be strong growth areas for the company and we are planning our China launch on April 20 in Beijing. We continue to invest and expand our global alliances and channel programs, and the Saba ecosystem now includes over 70 partners around the world and growing. This quarter, we added 12 partners including a new global relationship with Winthrop, additional resellers in China, Vietnam and Brazil, among others. Our partner community delivered over 50% of our new business and brought us our second largest deal in the quarter. We will continue to strategically add global HRO consulting partners as well as expand our reach to both resellers and influences in the regions.

On the product innovation front, our global Saba People Cloud infrastructure now shares nearly 5 million users. We are able to support the security, data privacy, performance and scalability requirements of the most demanding and complex organizations in the world.

Next week at the CLO Symposium in Florida, we will be announcing and showcasing an important new People Cloud application called Saba Social Learning, where this application leverages the strength of our formal learning heritage combined with informal learning so users can connect, interact and collaborate outside of the informal learning environment. Additionally, over the next 12 months, we plan to enhance our entire People Cloud Application portfolio with innovative new user experiences, new product functionality and extensive mobile support to further improve our customers' experience.

On building and inspiring company and brand, we added a significant talent across the company, adding key hires in marketing, consulting, cloud operations, sales and engineering. We hired a new leader to head our dedicated mid-market sales team. We also hired new leadership in our Southern European region and a new leader to head our Education and Government business in the United States.

Turning to guidance. We are forecasting bookings to grow in the range of 14% to 16% in fiscal year '11 over fiscal year '10. In closing, we delivered record growth across a number of key metrics, including total revenues, subscription revenue, bookings and deferred revenues. In addition, we saw a fourfold increase in the number of new SaaS transactions over $50,000 and our ACD new SaaS bookings increased 351% year-over-year. This was an exceptionally strong quarter by itself, but it's even more extraordinary given that we are in the midst of accelerating our business to the cloud. With that, I'll turn the call over to Bill to review the financial results.

William Slater

Thanks, Bobby. I will focus my review on our non-GAAP financial results and year-over-year growth rate unless otherwise stated. Total revenues in the third quarter reached a record $30.3 million, an increase of 14% compared to $26.7 million in the same quarter last year. Subscription revenues, which include our cloud business and our update and product support business, increased 17% to $16.7 million in the third quarter compared to $14.3 million in the same quarter last year. Customer adoption for our People Cloud offerings continues to grow.

Renewal rates on our subscription business were 86%. We experienced some update and product support anomalies in the quarter, but expect our renewal rates to return to 90-plus percent over the longer term. Our deferred revenue grew 18% in the quarter to a record $42.4 million, and our bookings, which we define as total revenues plus the change in deferred revenue, increased 15% to a record $37.1 million in the quarter. Total deferred revenue was reduced by approximately $1.6 million due to the adoption of ASU 2009-13, which is more commonly referred to as 08-01. Professional service revenue was $8.6 million in the quarter, up 26% from the same period in the prior year. Professional services revenue increased by approximately $1.1 million this quarter due to the adoption of 08-01.

08-01 allows us to recognize professional service revenue as the services are delivered rather than over the life of the related SaaS contract. The implementation of this accounting change required us to transfer that portion of service revenue that had already been delivered to the customer from deferred revenue to service revenue line on the income statement. While this accounting change was implemented this quarter, we have prospectively adopted 08-1 [ph] since the beginning of our first quarter of fiscal year 2011. The table at the back of the press release details these changes.

License revenue for the third quarter were $5 million, 9% lower than the same period in the prior year. As we noted earlier, we continued to see an acceleration toward Saba People Cloud offerings over traditional license transactions. During the quarter, we added 41 new customers compared to 22 new customers in the same period the prior year. The dollar value of our average deal size on a total contract value basis set another record high this quarter for the company, beating the record set last quarter. Operating expenses were $17.7 million for the fiscal third quarter, up 17% or $2.5 million above third quarter the prior year. The increase in operating expenses is primarily related to sales and marketing expense, which reflects our hiring in the field to support a strong bookings growth.

Starting with this quarter and adjusting retroactively, our sales commissions related to SaaS transactions will be capitalized and expensed ratably over the life of the SaaS contract as opposed to expensing them as incurred. This practice is consistent with industry standards. Again, the table at the back of the press release details these changes. We have also updated our income statement and balance sheet for FY '10 and for the first three quarters of FY '11 and have posted them on our website at investor.saba.com.

The net income for the third quarter was $1.6 million or $0.05 per share. The impact of accounting for sales commissions and the 08-01 accounting change, added $0.01 and $0.03, respectively to EPS in the third quarter and $0.02 and $0.03, respectively to EPS on a year-to-date basis.

We entered the third quarter with $32 million in cash compared to $28.9 million at the end of last quarter. Our day sales outstanding were 76 days, one day higher than the prior year period. Cash increased $3.2 million in the quarter to $32 million. Cash flow from operations for the quarter was $4 million dollars, an increase of 52% from the year-ago quarter. Cash flow from operations year-to-date was $1.6 million, down 65% from the prior year, due to the increased adoption of our cloud offerings over license transactions on a year-to-date basis, coupled with our increased investment in sales and marketing to support our strong bookings growth.

The company repurchased approximately 201,000 shares of stock during the third quarter for $1.3 million and approximately $6.9 million remains on our repurchase authorization. With regard to guidance for the fiscal year '11 ending May 31, 2011, we are forecasting bookings to grow on a range of 14% to 16% over fiscal year 2010. Our Saba People Cloud business continues to accelerate and we expect our license contribution to account for approximately 16% of total revenues in fiscal year 2011. Total revenue is forecasted to be in the range of $117 million to $119 million.

Due to our anticipated higher mix of cloud to license revenue, we expect GAAP net loss to range from $0.10 to $0.14 per share and non-GAAP fully diluted earnings per share to be in the range of $0.08 to $0.12 per share. With that, let me turn the call back to Roy.

Roy Lobo

Thank you, Bill. This concludes our prepared remarks. And we will be happy to take questions from the audience. Operator?

Question-and-Answer Session

Operator

[Operator Instructions]

Roy Lobo

While the operator is polling the audience for questions, I would like to inform everyone that Saba will be hosting a number of regional user conferences around the U.S. We will host a regional user conference in Chicago on April 6 and one in New York City on April 12. At both of the events, you will have the opportunity to hear and interact with existing and prospective customers as well as Saba executives. In addition, in the month of May, Saba will be presenting at the JMP, at The Benchmark, and at the B. Riley conferences. Let me turn the call back to the operator.

Operator

Thank you. And we do have a question from the line of Scott Berg with Feltl and Company.

Scott Berg - Feltl and Company, Inc.

First of all on the guidance, this is probably for Bill. Was your guidance that you gave at the end of the Second Quarter, on the Second Quarter call, did that factor in the implementation of ASU?

William Slater

Yes, it did. We have factored in both capitalized commissions and the impact of ASU 2009.

Scott Berg - Feltl and Company, Inc.

Fair enough. So you are bringing the top end down by $1 million on your guidance from three months ago today. Should we review that or view that as a reflection of the license pipelines continuing to switch over to SaaS-based contracts and naturally continuing or is there something else?

William Slater

Absolutely, Scott. I think we'd indicated in the last quarter conference call that we were expecting 18% of our revenues to come from licenses, and this quarter we dropped it to 16%, but we held bookings the same so we continue to see an accelerating shift towards our cloud offerings.

Scott Berg - Feltl and Company, Inc.

Fair enough, and I guess continuing that thought, do you have any timelines in mind currently as to when you'll most likely be switching over your product availability? So are we only selling SaaS-based solutions or do you continue to feel like you'll probably sell license for at least a few more quarters?

Bobby Yazdani

Scott, stay tuned for a series of announcements along those lines that we are getting organized around. And these would be announced after our fiscal year, conclusion of our fiscal year. We're going to have a major kick off of our sales organization in early June. That's the beginning of our new year, the new comp plans would be handed over to people, there's the territory plans. All of those are going to reflect the strategy of essentially moving the business and accelerating the movement of the business to the cloud.

William Slater

But Scott, as you can see, nine of our 12 largest deals in the quarter were in cloud deals.

Scott Berg - Feltl and Company, Inc.

Fair enough.

Bobby Yazdani

If I may, our focus is existing customers and the programmatic approach of moving our existing customers to the cloud.

Scott Berg - Feltl and Company, Inc.

My last question in terms of competitive landscape, did you see any major changes in the third quarter versus the second quarter and competitors who you saw, who you didn't see, maybe on the corporate learning side versus performance?

Bobby Yazdani

No, essentially, Scott, it's quite similar. The win rates during the quarter was, I would say, very good. We had very good win rates, what we call the conversion rate. The competitors remain to be the same. We are displacing a number of competitors in the enterprise learning market, and we are now getting our fair share of opportunities to compete in the performance management market. And again, our cloud offerings -- expanded cloud offerings, we believe that we will be able to essentially compete in the full suite as the market is converging towards the suite, but the landscape is similar.

Operator

Our next question comes from the line of Ryan Bergan with Craig-Hallum Capital.

Ryan Bergan -

Can you talk about public sector spending, in particular U.S. federal government and how that's impacting the business?

Bobby Yazdani

It's weaker than a year ago. There are many projects that are essentially at the federal level are stalled. We are seeing movement at the state and local level. We have a very good state and local pipeline. But the existing projects within the federal governments are fully funded. That's the color.

Ryan Bergan -

And then talk about the progress you're making, your sales headcount. I know it sounds like you had finally built out your mid-market team. You hired a person to lead the organization as well. I think you had 50 sales and marketing people at the end of last quarter. You were hoping to get to about 60 at the end of the fiscal year. What's your progress there?

Bobby Yazdani

We are getting very close to that 60 number, and we have actually have authorized to hire, go beyond the 60 at this point.

Ryan Bergan -

Do have a number that you're targeting beyond 60?

Bobby Yazdani

I would like to, for our kick off, for our new kick off coming June of next year, our next fiscal year, I'd like to see that number to be closer to 70 people.

Ryan Bergan -

And where are those people manned [ph]? Are they midmarket or are they going to fall elsewhere?

Bobby Yazdani

They are a combination of international markets, where we are hiring senior account executives, we are hiring our midmarket team, we are hiring folks in our channels and channel management, where they're carrying quotas with our channel partners. We are also hiring and broadening the client executive team where we are programmatically going to manage the installed base of the behind the firewall customers for convergence to our cloud business. So that's a very strategic expansion for us and we are going to double the number of those people over the course of the next fiscal year.

Ryan Bergan -

And then can you talk a little bit more about your China launch that you said you're planning for April 20? What kind of opportunities do you see there and what's the competitive landscape in China?

Bobby Yazdani

We have a number of partners both strategic, large integrators like IBM and HP, who we have partnered in that market, and we have number of local partners. We felt that we have sold and we have projects, live projects right now in China, whether they are multinationals who are expanding the installations into China or they are Chinese companies who are starting their projects within China. We feel that it's extremely important for the success of our customers to have a local team, both technical as well as sales representative in the market. The number of our multinational customers are partnering with us for that expansion, as well as our major partners like IBM, to have a presence in China. You will see an expanded sales team and you will see an expanded technical support team on the ground there. The competitive landscape is actually competing with local Chinese suppliers as well as the international companies who have presence in China. And we feel that we have actually quite a few years of experience in China where multinationals have deployed our solution in the local Chinese market, and we have been exposed to that market. We feel that the market is now converged. It's more mature than two or three years ago. It shows up in our partners, pipeline, direct inquiry from China, and we now have local sales executives on the ground. So it's very promising expansion for Saba next year.

Operator

And our next question comes from the line of Kevin Liu with B. Riley Company.

Kevin Liu - B. Riley & Co., LLC

First question, Bill, you said there's some anomalies in the maintenance renewal rates in the quarter. Just wondering if we can get a little bit more color around there. And then just as you make the transition or trying to transition some of your enterprise customers over to the cloud, curious what sort of impact that has on the maintenance versus the SaaS revenues you could pick up.

William Slater

You know, Kevin, there are a number of disparate issues that conspired against us on maintenance revenue this quarter. We're typically in the 90s, so there's no trend. We just got hit by a couple of different things. We're not seeing -- at this point, we have not engaged in very many situations where our behind the firewall customers are moving to SaaS. We do have two or three that are being worked on currently. We assume that the opportunity here is to increase our revenue as customers move from the firewall to our SaaS offerings.

Kevin Liu - B. Riley & Co., LLC

And typically, when you start to get more SaaS revenues and less perpetual, you would start to see professional services tick down as well. So far it still remained at a fairly elevated levels. I was just curious as we look into the upcoming fiscal year, kind of what your expectations are for an appropriate run rate there?

William Slater

Well, we still think there are professional services to be used in any type of conversions from behind the firewall. Yes, we think that's a huge opportunity for our Professional Service group.

Bobby Yazdani

Let me comment. We are not selling to SMB markets, our cloud offerings. I would say that we've closed two of our largest daily business of the company, which was a cloud offering to S&P 500 type companies on global deployments. So these global deployments start with typically handful of markets and then it gets expanded to a global deployment. The nature of the customers that we service whether they are public sector customers, defense customers, pharmaceutical, they are large and they're global. And we work with these clients not necessarily in an integration job, it's more about business process, design, and it's all mostly about business consulting rather than technical consulting.

Kevin Liu - B. Riley & Co., LLC

That's helpful. And on the OpEX side, I wanted to you touch on the sales and marketing line, retention, accounting, reduced the amount of commissions recognized. But it still seems like a pretty big sequential drop off so I'm curious what...

William Slater

I think the drop off wasn't as much the commissions. In our second quarter, we have our yearly summit, which is a large expense for us. And then, of course, we typically see the third quarter seasonally down when the summit's over. So we typically see a spike in our fourth quarter because it's typically the end of the year, and it's the highest commission rate. So we see this see-saw pattern in our sales and marketing expense.

Kevin Liu - B. Riley & Co., LLC

So we should expect that number to tick back upwards at the end of the quarter?

William Slater

Yes. I think the commission impacted in the third quarter was relatively modest. You're seeing a $1 million drop from the second quarter to third quarter. I think commissions was only $300,000 or $700,000 related to the summit.

Kevin Liu - B. Riley & Co., LLC

And then also on the G&A line, just notice that it ticked up a bit sequentially. Anything we should be aware of there?

William Slater

Yes, I think we had some cost associated with getting the preference letter for capitalizing commissions on SaaS and we also had some costs for audit, legal and outside consults helping to do the conversion on 08-01. So we just had a pickup in quarterly costs for those things.

Kevin Liu - B. Riley & Co., LLC

And my last question here, obviously, your valuations can get a little bit better here and I think you guys have executed really well, but there's still a pretty clear valuation disparity between you guys and some of your peers out there. You now have one of your competitors actively talking about wanting to buy an enterprise, OMS company. So just wanted to get a sense for what your view as management and what the board's view is toward achieving a higher valuation, either in terms of staying the course or perhaps exploring what this competitor might be willing to pay.

Bobby Yazdani

We come at it in two different ways. I think, first of all, I think the board has spoken on this topic and that's why they've authorized the company to purchase, or repurchase program of our shares. It speaks volume that the board feels that the company significantly is undervalued. We are buying as much as we are allowed with the volume restrictions and the relative window where we can purchase these shares. So that's in terms of the opinion of the board, our current valuation. And secondly, I think we believe that there's significant potential for us to increase our valuation as we are transforming our business to the cloud. Some of the competitors you've mentioned or you're referring to maybe have significant revenue above them, even our SaaS business is significantly bigger than theirs. And the work that we’ve started around our IR program and communicating the value that we delivered to the market. Today, investors, that's a program that we started earlier this year. We are hoping that would help. And we are participating a number of conferences where investors are learning more about what we do and the value that we provide and we are hoping that we'll catch up. Another thing that can be helpful is, Kevin yourself. I mean, at $10 a share does not reflect the fair value on the company. And I encourage you guys to revisit the prices you guys are putting on the value of Saba

Operator

[Operator Instructions] And I have no further questions. Thank you. Please continue.

Roy Lobo

Thank you, operator. A telephone replay of this conference call can be accessed by dialing 1-800-475-6701 with the access code of 195348. You can also access the replay of this call by going to the Investor Relations section of our website at investor.saba.com. The replay will be available through April 15, 2011. Thank you, everyone, for joining us in today's conference call, and I will turn the call back to the operator to conclude this call.

Operator

Thank you. And ladies and gentlemen, that does conclude your call for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.

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