Saba Software F1Q08 (Qtr End 8/31/07) Earnings Call Transcript

TRANSCRIPT SPONSOR

Saba Software (SABA)
F1Q08 Earnings Call
October 4, 2007 5:00 pm ET

Executives

David Lebedeff – IR
Bobby Yazdani - Chairman and CEO
Mike Martini – CFO

Analysts

Michael Nemeroff - Wedbush
Eric Martinuzzi - Craig-Hallum
Andrey Glukhov - Brean Murray

Presentation

Operator

Welcome to the Saba first quarter fiscal year 2008 financial results conference call. (Operator Instructions) I would now like to turn the conference over to our host, Mr. David Lebedeff. Please go ahead.

David Lebedeff

Good afternoon and welcome to the Saba Software first quarter 2008 conference call. I am David Lebedeff, Saba's Vice President of Investor Relations. Today we will discuss our financial results for the first quarter ended August 31, 2007. With me today is Chairman and Chief Executive Officer Bobby Yazdani and Chief Financial Officer Mike Martini.

Before I begin, I would like to point out that certain remarks made in the course of this conference call are forward-looking statements. These statements include, but are not limited to: Saba's future performance and financial projections; increasing customer adoption of our OnDemand offerings; OnDemand solutions dominating our business over time; the percentage of quarterly bookings recognized in future periods; growing market interest in our solutions that support our 2008 revenue guidance; and our ability to grow our business and generate profits, expand our footprint to include compensation in workforce planning, drive revenue through indirect channels, including our newly expanded relationship with a large BPO company; and generate cash from operations.

These statements are based solely on information available to us today and reflect management's current expectations and beliefs, and are subject to numerous risks and uncertainties. It is important to note that our actual results could differ materially from those contained in such forward-looking statements.

Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in our annual report on Form 10-K for the year ended May 31, 2007 and in similar disclosures in subsequent Saba periodic SEC reports. Copies of these reports may be obtained from the SEC. We disclaim any duty to update such statements.

In addition, we intend to discuss today both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP results is included with the financial statements accompanying our earnings release and is available on our website at www.Saba.com. Saba's management believes that non-GAAP information is an additional, meaningful measure of operating performance because it measures the principal operating results that can be directly influenced by management, and provides more consistent comparability to our financial results against historical results and the reported results of other software companies.

Let me now turn the call over to Mike Martini, Chief Financial Officer of Saba.

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Mike Martini

Thanks, David. I will report today on first quarter 2008 results and I will give guidance for second quarter and full year 2008.

During my first quarter at Saba, I was able to make a number of calls to members of the investment community in which I described my interest in joining Saba, and how I believe the company is well positioned in the market. Let me summarize those conversations by saying that I truly believe this company has the right solutions at the right time, and is in an excellent position to take advantage of the large, addressable market for human capital management solutions.

Before I review the results, let me make a few observations on my initial impressions of the company. I am pleased to find that the software and services we offer are not only what our customers are looking for, but are also industrial strength, enterprise class software solutions. The core of any software company is its products and Saba's software portfolio is in fine shape.

In fact, we have the ability to deliver our products in any manner a customer wants to purchase them. We sell them lumped together on a unified platform as an integrated suite, or we sell them a la carte. We sell them directly through our own sales force or indirectly through our Saba Alliance’s partners. We can sell them on a license basis and let the customer run the software behind their firewall. This is the preferred and only way some of our large enterprise and governmental customers will purchase our software. We also offer our software solutions on an OnDemand, multi-tenant, Software as a Service basis. This is the predominant method of sale to our middle-market customers, and is gaining adoption with our Tier 1 customers. These OnDemand solutions will likely come to dominate our business over time.

However, we also believe we should sell our solutions in whichever models customers choose to buy. Customers choose solutions, they don't buy business models. By selling our solutions, using licensed or OnDemand models -- a hybrid approach -- we believe that we have a greater competitive advantage to capture customers and generate more revenue.

I would also like to review with you how these models impact the balance sheet and how sales flow into revenue, often by way of the balance sheet. In terms of our licensed businesses, there are actually three revenue flows: the software license sale, license update and product support, and professional services fees. License fees from licenses with a term of three years or more are generally recognized on contract signing. License fees typically range anywhere from $50,000 to $2 million, with an average license fee of $200,000. In the metrics that I will provide, assume that license deals are recognized on contract signing.

License updates and product support revenues are recognized ratably over the term of the arrangement, typically 12 months. As such, in any given quarter, only a small portion -- say 8% on average -- of these revenues associated with new license sales will appear in revenue during the quarter, with the remainder going into deferred revenue on the balance sheet.

Revenue related to professional services is generally recognized as the services are performed. Although our customer engagements may represent contractual commitments stretching over several quarters, the majority of our current quarter revenue is from billable hours within the quarter and only a small portion -- about 5% on average -- will go into deferred revenue on the balance sheet.

Revenue from our OnDemand offering is recognized as a service arrangement whereby the revenue is generally recognized ratably over the term of the arrangement. Most contracts are one to three years in length. In this case, only a very small portion -- less than 10% -- will be recognized as revenue in the quarter of booking, with the remainder going into deferred revenue on the balance sheet.

The good news -- revenue sits on the balance sheet awaiting release over a number of quarters. The bad news -- the revenue sits on the balance sheet awaiting release over a number of quarters, and hides the underlying, current growth in our business.

In summary, during any particular quarter depending on the mix, approximately 60% to 70% of revenue booked in the quarter will be recognized in future periods. We are beginning to build a nice stockpile of future revenue flow, which you should expect to see build in deferred revenue before flowing into revenue in future periods.

Now let me review the results for the quarter, and I will provide you with guidance for the remainder of the year later in the call. We added 34 net new customers in the first quarter 2008, up from 14 new customers in the first quarter 2007. Moreover, we completed 74 license deals and 75 OnDemand deals in the quarter. We are seeing activity with customer prospects in all geographies, product lines, and revenue lines.

Not only are we seeing increased interest in our OnDemand solutions from the middle market, but we are also seeing plenty of activity and interest in the license solutions for larger enterprises as well. Large global customers are showing particular interest in our integrated people management solutions. While it can be difficult to forecast exactly when these prospects may become customers, we believe this activity supports our revenue guidance for 2008.

We have confidence that market interest in our learning, performance and talent, and collaboration solutions is healthy and growing. Total revenues in the first quarter of fiscal 2008 were $25.5 million. This was within our guidance for total revenues of $25 million to $26 million and this is up about 10% from the first quarter of 2007 on a GAAP basis.

We had an unusually large customer booking during the first quarter of 2007, coupled with revenue writedowns from purchase accounting, making year-over-year comparisons a bit difficult. U.S. revenue was 68% of total revenues and international revenue was 32% in the first quarter.

License revenue in the first quarter was $4.7 million. This is down from the prior year first quarter for the reasons cited earlier. Additionally, during the quarter we booked a license deal, along with receiving product development funding for a combined $1.4 million contract which did not get recognized in this quarter. Bobby will have more to say later about this deal.

In the first quarter, OnDemand revenue increased 25% to $4.4 million from $3.6 million in the same quarter of the prior fiscal year. Our license update and product support revenue in the first quarter of fiscal 2008 increased 26% to $8.8 million from $7 million in the same quarter last year. As indicated on our calls in prior quarters, our business strategy includes continued focus on growing our recurring revenue base. In the quarter, OnDemand revenue and license update and product support revenue combined to represent 52% of total revenues.

Professional services revenue increased 17% in the first quarter of fiscal 2008 to $7.5 million from $6.4 million in the first quarter of fiscal 2007.

Overall gross margin was 62% in the quarter, a decrease from 63% in the first quarter of fiscal 2007. Gross margin will move each quarter, mainly from the amount of license revenues we recognized in the quarter. Included in gross margin is approximately $300,000 of intangible amortization and stock-based compensation of $100,000.

License gross margin was 96%; license update and product support was 75%; OnDemand gross margin was 63%; and professional services gross margins were 28% in the first quarter, a decrease from our recent trend of greater than 30% but an increase from our first quarter of last year. Professional services margin in the first quarter are typically lower as a result of the summer holiday months.

Total operating expenses were $17.9 million in the first quarter of fiscal 2008 compared to $16.9 million in the first quarter of fiscal 2007. Total operating expenses in the first quarter of fiscal 2008 included amortization of total purchase intangible assets of $634,000 and stock-based compensation of $1.2 million. Included in this amount was an additional one-time, non-cash stock compensation charge of $631,000 related to an employment agreement amendment which modified the events that triggered accelerated vesting of options. This issue and the associated calculation for the additional charges was technically complex, but in short, advanced much of what would have been normal stock compensation charges to be taken in future periods into the first quarter. Depreciation expense for the quarter was approximately $500,000.

On a GAAP basis, our net loss for the quarter was $2.4 million or $0.08 per share, compared to a net loss of $2.6 million or $0.09 per share in the first quarter of fiscal 2007. This was within the range of our guidance last quarter for a loss of $0.06 to $0.09 on a GAAP basis.

Non-GAAP net income and earnings per share were breakeven in the quarter, compared to non-GAAP net income of $1 million or $0.04 on a basic and diluted basis in the first quarter of fiscal 2007. This was within the range of our guidance last quarter for breakeven to a loss of $0.03 on a non-GAAP basis.

We ended the first quarter with $29.7 million of deferred revenue, up slightly from deferred revenue of $29.5 million at the end of the last quarter and a 21% increase from $24.5 million in the same quarter of the prior year. I am also providing you with additional information about the breakdown of our deferred revenue by revenue category.

For the first quarter 2008, 5% of deferred revenue was from license, 58% from license update and product support, 28% from OnDemand, and 9% from professional services. These percentages are nearly identical to the fourth quarter 2007, where 5% of deferred revenue was from license, 60% from license update and product support, 27% from OnDemand, and 8% from professional services. Although the deferred revenue balance and its components remain nearly unchanged from the prior quarter, Saba was able to maintain this inventory of revenue for future use during the first quarter, which is traditionally the lowest sales quarter for the year, as a result of the summer holiday months.

We ended the first quarter with $11.8 million in cash and cash equivalents. We also accelerated our pay down of our debt obligation by approximately $2.4 million during the quarter, and we spent about $800,000 on capital expenditures. We anticipate being operating cash flow positive over the balance of the year.

Our DSO for the quarter was 85 days, approximately the same as the first quarter last year. We expect DSOs to continue to fluctuate based on the number and size of transactions that close in the last month of the quarter. DSOs should be in the 70 to 80-day range going forward.

Let me now turn the call over to Bobby for his comments before returning with our outlook for the second quarter and the rest of the year.

Bobby Yazdani

Thanks, Mike. I would like to discuss two topics with you today. First I would like to review our priorities for the past three years to give you perspective of where we have been and where we are heading. Second, I would like to give you an update on our channel strategy.

During the last several years we have had four priorities for Saba: build revenue to $100 million annual run rate; build a customer base in learning management from our key customers in key verticals; build a strong, unified product line based on our owned intellectual property; and enhance visibility by increasing sources of recurring revenue. These priorities have now positioned us to grow our business and generate profits for shareholders.

In today's environment, a company has to be of a certain size to afford the cost of being a publicly traded company and to drive down the average selling and transactional costs of the business. At $100 million in annual revenue, we believe we have the scale to absorb these costs of doing business and organically grow our business. From this platform, we believe we can generate initial EBITDA net margins of 10% to 15%, and possibly higher net margin as we continue to scale and grow the business.

It has been a priority for us to grow our business in learning management with large, more key, customers. Now that our solutions are used by more than 1,200 organizations globally, we can now upsell our broader product offerings and drive the business into the middle market. We have large reference customers in dozens of different industry segments. Our products run mission-critical applications for some of the largest enterprises and governmental entities in the world.

We also believe that learning management is the best market segment to start from in the HCM space. Learning management solutions have a large footprint within an organization. They tend to be adopted across an entire organization. As you can imagine, once our solutions are adopted within an organization, it is a very sticky application. Our solutions are deployed in an organization, they stay in and our customers want more applications.

From our base in learning management, we are expanding our offerings to include performance and talent management. Our customers are telling us they want more solutions from the same vendor, that are integrated and unified on the same technology platform. There will be more to come as we are expanding our HCM footprint to include compensation and workforce planning to internal development. This is why taking the time to build our solution based on our own intellectual property was so important, so our solutions could operate on the same technology platform whether we sold them together or independently. Our common platform provides a seamless user experience, simplified reporting, and a common repository of people information, organizational information and competencies. A common technology platform results in easier deployments and lower cost of ownership.

To that end, we recently announced the general availability of Saba Enterprise 5.4. This release enables companies to track and manage individual and organizational performance, blended learning, talent planning and development, and interact and exchange knowledge online in real-time. Saba Enterprise 5.4 is built on a robust, advanced architecture based on open standards, providing enterprise class security, scalability and reliability. Our solution can be deployed OnDemand or on premise to meet a wide variety of organizational requirements.

Now more than ever, our customers are looking to consolidate disparate IT systems and reduce costs without compromising organizational efficiency. By delivering a complete people management platform that includes the industry's best practices for people management, our customers have a unified solution that can help them to develop and manage their most important assets – people -- and improve organizational performance.

For my second topic, let me spend some time discussing our indirect sales efforts. Historically, we have primarily used a direct sales force to sell our HCM solutions. Several years ago, we began expanding our sales channels by establishing the Saba Alliances Program. By leveraging Saba Alliances, we have established strong partnerships with leading vendors throughout the world, including system integrators and consultants, VARs and distributors. These best of breed partners helped expand our HCM offerings to businesses and governments around the globe. This group includes alliances with HCL Technologies, IBM Business Consulting Services, and Deloitte Consulting, just to name a few. In total, we have dozens of other companies actively selling Saba software.

Product sales to indirect channels vary by region. North America ranges from about 10% to 25% and our international markets have a higher percentage of indirect sales. I would put them between 25% to 40%. There really is not a consistent pattern with large resellers; you are – and it is very dependent on which large opportunities come along in any given time period; but this may soon change.

During the quarter we signed an agreement and booked our second deal with a very large BPO partner. Because of the contractual confidentiality issues, we are unable at this time to release the name of the company. However under the current earnings ramp, Saba booked during the quarter a license deal for performance and talent management worth over $500,000. Saba is also receiving additional funding of nearly $1 million to accelerate product development efforts to bring workforce planning and compensation management for general market availability.

Although we have recognized no revenue from this transaction in the first quarter, we believe it will be recognized in full over the remainder of the year. More importantly, the BPO customer currently sells its solution to over 1,000 of its customers with some very large enterprises. The intent of our agreement is to replace the BPO’s inhouse product and standardize Saba as their platform, with the intent to sell into the BPOs 100-plus customer base.

While we do not know the timing or the full impact of this agreement, this relationship has already produced our second large new customer, funding for new solutions, and the prospect of a highly-leveraged name brand sales channel.

In summary, our objective is to speed market adoption and accelerate customer growth in the market for our HCM solutions. We believe that our indirect leverage sales strategy allows us to accomplish these goals in a cost effective, yet timely, manner.

Now I will turn the call over to Mike for his comments on our financial expectations.

Mike Martini

Thank you, Bobby. Before I provide you with guidance, I would like to discuss some of the trends underlying our business. As previously mentioned, Saba sells all its products in either a licensed or OnDemand format, depending on customer needs. We believe that over the long run, our customers will buy more of our products on an OnDemand basis. But this is a process that will likely take some time to complete. Other software companies have undertaken this transition, which has taken three or four years or more to transition to a model dominated by OnDemand.

The current breakdown of our revenue on the income statement is approximately 80% license and 20% from OnDemand. However, the new business being booked is about 50% license and 50% OnDemand, so the shift towards OnDemand is occurring, although slowly. Eventually, this trend should help reduce the lumpiness in quarterly revenues as we continue to grow and transition to a more OnDemand company.

Although we anticipate good organic revenue growth during 2008, we are doubling down our efforts to provide even stronger EPS growth. Our business going forward should gain some leverage from our existing cost structure as we grow revenues. On average for the year, we expect overall gross margins to be between 64% to 67%. Although we still have some opportunities for improvement, the underlining fundamentals of price and cost across all elements of gross margin are good. Overall, gross margins are not likely to be an issue this year.

General and administrative cost as a percent of revenue should remain in the 11% to 12% range; also good news, as Saba continues to do an excellent job maintaining benchmark levels for a public company this size. Product development costs should be in the range of 15% to 16%, which is also a good benchmark level with a strong commitment to keep product innovation a very high priority.

Finally, we spent 38% of revenue on marketing and sales during the year ended May 31. This is on the high side of where we would like to be. There continue to be additional sales and marketing reduction opportunities worldwide, especially in sales support costs. We have begun a focused effort at reducing our sales and marketing costs beginning early second quarter, and we believe the second quarter benefits will offset much of the one-time charges, including employee severance. Therefore, we will do this without taking a restructuring charge. If any of the costs aren't self-funded by savings during the second quarter, the one-time charges not covered by savings should not negatively impact EPS by more than $0.01 during the quarter. We expect this to have a positive EPS impact in the third and fourth quarters.

A good target to model for Saba's sales and marketing during 2008 would be around 32% by fourth quarter, with longer run costs being about 27% to 32% of revenues. We are not reducing our quota-carrying headcount, as this will continue to grow as revenues grow. We are also likely to gain more traction leveraging other reseller and indirect channels.

Now let me turn to our guidance. The guidance for the second quarter 2008 is as follows: we believe total revenues for the period will be between $26 million and $27 million; we expect the split between license and OnDemand revenue to be about 80% to 85% licensed and 15 to 20% OnDemand. Total gross margins are expected to increase to approximately 63%, which includes the impact of amortization of acquired developed technology of $300,000 and stock-based compensation of $100,000.

Operating expenses are expected to increase slightly over the first quarter 2008. This is due to an increase in variable costs related to higher product bookings and costs associated with our annual user conference. This should be partially offset by lower stock comp charges. Cost savings from our recent sales and marketing restructuring activities will start to be seen in our third quarter.

On a GAAP basis, we expect a net loss between $1 million and $1.8 million for the second quarter, and a loss per share of between $0.03 and $0.06 per share on a base of approximately 29 million shares.

Our guidance for non-GAAP earnings per diluted share for the second quarter is expected to be between breakeven and $0.03 per share on a base of approximately 30 million shares. Our overall cash balance is expected to be slightly up from the end of the first quarter, and total capital expenditures will be in the range of about $800,000. We also anticipate that our depreciation expense will be about $500,000 for the quarter.

Now for the guidance for the full year 2008. Based on our performance in the first quarter, we reaffirm our previous full year guidance for total revenues between $110 million to $115 million for 2008. We expect license revenues to represent between 80% to 85% and OnDemand revenues ranging 15% to 20%. We expect gross margins to increase during 2008 with fourth quarter gross margins of about 67%, with an average of about 65% for the full year. Included in this amount is the amortization of acquired developed technology of about $1.2 million, and stock-based compensation of $500,000. We would expect to exceed 68% over a longer period of time.

As previously mentioned, we intend to seek out leverage in our operating cost structure which can mean reallocating some cost towards revenue-producing endeavors, redirecting some to lower-cost geographies, and eliminating some through other efficiencies. We are targeting a relatively flat operating cost structure for 2008, which should help us achieve our bottom line objectives. We also expect depreciation expense to run about $500,000 per quarter.

We expect non-cash amortization of purchased intangibles expense to continue at approximately $900,000 per quarter and charges related to stock-based compensation expenses should drop back to about $750,000 per quarter and amortization of acquired backlog of approximately $100,000 per quarter.

On a GAAP basis, we would expect earnings to show a net loss between $3 million and net income of breakeven for 2008 and net earnings per share for fiscal 2008 to range from a loss of $0.10 to breakeven on a base of approximately 29.2 million shares. The only change to this annual GAAP EPS number is the impact on the additional first quarter stock compensation charges previously discussed.

We expect to achieve non-GAAP earnings between $4.5 million and $7.5 million and we would still expect non-GAAP earnings per diluted share between $0.15 and $0.25 for 2008 on a base of about 30.2 million shares. We expect capital expenditures to run about $800,000 per quarter and we expect the full-year cash from operations to be positive.

Let me conclude by saying I am very pleased to be here at Saba. I see a market-leading company in an emerging market with huge potential. I am impressed with the management team here at Saba, and I look forward to working with my colleagues to grow the company.

Now let me turn the call back to David.

David Lebedeff

Thanks, Mike. I wanted to mention that we will be presenting the Saba story at the AEA Financial Conference November 5 and 6 in Monterrey. We also plan to partner with our sell side analysts to visit their clients and educate investors on the Saba story during the current quarter.

We will now take your questions. As part of our ongoing communication with all of you, we provide forward-looking financial guidance on our quarterly conference calls. You all are aware that Reg FD has rules that we must adhere to in our communications with investors. Therefore, I would encourage you to ask any questions that you have during the question-and-answer session, which you believe are necessary in developing your models and estimates. We will be limited in our future conversations by what is discussed on today's conference call.

Let me now turn the call back to the conference call operator.

Question-and-Answer Session

Operator

Your first question comes from Michael Nemeroff - Wedbush.

Michael Nemeroff – Wedbush

A couple of questions. Looking at the OnDemand growth, maybe on a non-GAAP basis, it looks like it's a little under 8%. I was just wondering how that compares? Then the number that you threw out on the deferred revenue, the growth year over year, you were using short-term deferred, but the total of the two was about 14%. Is that the growth rate that we should assume for the company going forward, as where you think the company should grow?

Bobby Yazdani

Michael, let me take the first part of your question. When we acquired Sentra, they had a legacy SMB OnDemand business that over the course of the past 12 months we have essentially exited. There was a whole bunch of OnDemand revenue that is being contributed to the web conferencing segment of the Sentra business we essentially have abandoned in the SMB market. We replaced that business with what we typically sell into, which is the high end of the mid-market or the large enterprise.

I'll give you the story in terms of the year over year. We are pleased with the current mix of revenue being 50% OnDemand, 50% license revenue from the market that we like, which is the high end of the mid-market and the large enterprise.

Michael Nemeroff – Wedbush

When was that revenue completely run off from web conferencing so we can have a proper year-over-year comparison? Or when can we have a proper year-over-year comparison for the non-web conferencing OnDemand piece of the business?

Bobby Yazdani

It's hard to give you an exact date because we have customers who are using that service and of course we're not going to turn off the service we are providing to those clients. We are not proactively adding customers. All the new customers that were announced on this call are primarily coming from the high end of the mid-market, enterprise. My expectation is over the course of the next 12 months it is just going to keep going down as we are not selling into that market.

Michael Nemeroff – Wedbush

On the deferred revenue growth, the 17% short term versus the 14% total, what comprises that long-term deferred revenue and should we look at that 14% as more of a true organic growth of the company going forward?

Bobby Yazdani

In our call we mentioned that we think that the market is growing between 10% to 15%. That's our high level view of the market. North of the 15% we are gaining market share. I think that's a fair number you put out there, north of 15% is what we are chasing.

Michael Nemeroff – Wedbush

Mike, you'd given some breakdown on the components of the deferred revenue from Q1 of this year and Q4 of last year. Can you give us the breakdown of the deferred revenue from Q1 of last year so we can determine some growth rates?

Mike Martini

I'll do this off the top of my head and approximate, but I think it's pretty close. You are talking about 1Q07?

Michael Nemeroff – Wedbush

1Q07, correct.

Mike Martini

Services about 11%, OnDemand about 23%, support 63% and license is the difference.

Michael Nemeroff – Wedbush

How many quota-carrying sales reps are there currently and could you characterize if there has been any turnover recently?

Bobby Yazdani

There are roughly 45 quota-carrying reps and traditionally we make the changes towards the end of Q4, early Q1 as we do assessments of the talent and reallocation of the territories.

Michael Nemeroff – Wedbush

That's an increase of five from last quarter, I think you had 40 at the end of last quarter?

Bobby Yazdani

That's correct.

Michael Nemeroff – Wedbush

The variance on that EPS guidance, you could actually drive a truck through it. I'm just wondering, are there any large deals, mega deals that are in the pipeline, either license that you're working on currently that could get you to that $0.25 or is that $0.10 differential on the guidance going to be just through blocking and tackling on the cost-cutting side?

Mike Martini

I'm still rather new here and I'm quite comfortable having a wide range so we can drive something through it. If you look, generally speaking, at what we have to do for the next quarters and you match that with the business activity; plus remember the unnamed customer that Bobby talked about is all performance and talent. That's one of our brand new products and we expect that to be a catalyst that's going to hopefully drive that. In the next call I'll be able to narrow that down even more for you, but right now I'm so new that I'm quite comfortable at pacing it right there.

Operator

Your next question comes from Eric Martinuzzi - Craig-Hallum.

Eric Martinuzzi - Craig-Hallum

My question has to do with the gross margins. I'm curious about the OnDemand segment. We're down sequentially and we're down year over year, yet that's one of the areas that had been growing nicely. Can you comment on those gross margins?

Mike Martini

This is a big area of our business like we talked about earlier, that a large part of our activity is coming through there just on the demand side. What we want to do is make sure that we have the right talent and the right infrastructure in place to ensure that going forward. You can see the gross margin, the primary drop for the gross margin is both infrastructure and headcount related. You'll see this type of a business running at somewhat of a step function where in order to fulfill demand, you'll have to step up with your cost structure a bit and then run it out a long time over that. So you ought to look forward to that gross margin improving as we book more and more business because we won't have to add a whole lot of cost structure to it.

Eric Martinuzzi - Craig-Hallum

So we should see that up then, in the November quarter?

Mike Martini

That's right.

Eric Martinuzzi - Craig-Hallum

On the cash side net of the debt out there we're down below $10 million now. I understand the cash balance itself is higher than that, but backing out the -- you know, the last time we got into this situation we were able to acquire Sentra and its good strong cash balance. Is there an issue here with access to capital maybe bumping up against some working capital constraints?

Mike Martini

I think first of all maybe the question behind the question is, are you concerned with your cash balance? No. To answer the second part of it, no we are not concerned with access to cash. I am not right now concerned with our cash balance. We are projecting to be cash flow positive going forward. In fact, we were comfortable from the cash balances that we decided to pay down the debt quicker because I would just as soon get rid of the debt and get on with things than to hold the money earning 5%.

The other major change in cash, you can see it, it's in the receivable amount which is partly business activity and partly related to an Oracle cutover that we had just prior to my joining where we had invoices out late as a result of it, and they just weren't collected in the quarter. That also gives me confidence that they will be collected in the second quarter that we're in, all of the backlog receivables.

So I think from a cash standpoint, I’d rather have $100 million but I don’t think it should be a concern right now.

Eric Martinuzzi - Craig-Hallum

Just back to the top line and the organic revenue for the top line, we were roughly flat in Q4 and roughly flat here in Q1; we're guiding down Q2 versus Q2 a year ago – and again, this is organic growth I am talking about. Does that imply an acceleration towards the OnDemand bookings? Because I see that the bookings still seem to be pretty strong, but I'm concerned and I know we have a little bit of a tougher comp November a year ago, but I was surprised to see the organic revenue guided down year over year.

Mike Martini

Our annual guidance is in the mid-teens, 10% to 15%, so it sounds like you are addressing your concerns from our second quarter guidance that we provided.

Eric Martinuzzi - Craig-Hallum

Right.

Mike Martini

As compared to last second quarter. Here's what I guess would be a worthy takeaway is given that guidance, you could assume in hitting the end of the year numbers, that we have to have fairly strong third and fourth quarters. In order to provide that guidance, we have to have a lot of comfort with our business activity that is going on, and we do. You should be aware that we plan on selling a lot more of our new product that wasn't in there last year that will give us the ability to rather quickly grow a quarter's revenue. I think on balance, I'm feeling okay about it, but I understand your question.

Operator

Your next question comes from Andrey Glukhov - Brean Murray.

Andrey Glukhov - Brean Murray

Mike, can you talk about the funding that you're receiving from your BPO partner to accelerate the product development? So you're getting $1 million, how are you floating it through the P&L? Is it going to be concentrated in a particular quarter or is it going to be spread out?

Mike Martini

You aren’t talking about the product nature of it; you're just talking about how the financials will flow?

Andrey Glukhov - Brean Murray

Correct.

Mike Martini

Part of it is, I'm not quite sure yet to be honest. When you get into the licensed portion of it, it was really, really easy. Normally we just would have booked that. The funded product development takes on a life of its own in revenue recognition and so my initial assessment of it is it would probably be booked ratably over the last three quarters of the year, but I'm not certain of that. It could skip the second quarter and go to the third and fourth quarter; it could all be booked in the fourth quarter. It will be booked all this year, I'm just not quite certain of the timing. Sorry to be evasive, but if I knew, you would know.

Andrey Glukhov - Brean Murray

Just to be clear, you're booking it as revenue, not as an offset to R&D?

Mike Martini

That's exactly right. It will probably be a component of product revenue and services revenue, for lack of another category.

Andrey Glukhov - Brean Murray

Bobby, you have 45 sales guys going into the year. Given the level of bookings here, it sounds like your sales guys are bringing meaningfully less than $1 million a year in bookings. I think you guys have postulated that you're willing to cut sales engineers, you're not willing to cut sales reps. Don't you think that you are overstaffed on the sales headcount?

Bobby Yazdani

I don't think we've talked about the levels of bookings. I think we are pleased with the first quarter business activities. With Q1 being the first quarter, a summer quarter, I don't think it's a good idea to judge the remainder of the year's activity just looking at the Q1. But we were pleased with the Q1 and we are looking for the remainder of the year, to remain to be very positive on the business opportunities that our guys are chasing.

We are not looking to cut the sales capacity and sales coverage; we are looking to more realign essentially the non-quota carrying costs.

Andrey Glukhov - Brean Murray

Let me ask you a different way. What quota attainment order of magnitude do you guys assume in your numbers to justify 45 sales guys?

Bobby Yazdani

We have not shared that internal number.

Andrey Glukhov - Brean Murray

It sounds like you are not going to do it now.

Bobby Yazdani

No.

Andrey Glukhov - Brean Murray

Lastly, I missed it – what was the actual cash from ops in the quarter?

Mike Martini

Cash from ops was roughly about negative $3.7 million.

Operator

Your next question comes from Michael Nemeroff – Wedbush.

Michael Nemeroff – Wedbush

Bobby, how many customers are using multiple products right now? What percentage of the customer base?

Bobby Yazdani

That’s a good question. More than 20% are using at least two of our products. The real important data is that roughly about 18% of our customer base – 18% to 20% of our customer base at the end of Q4 is in our old version of Saba, so we have had a very good movement over the past two quarters and the current quarter of people upgrading to the latest version of our product.

Michael Nemeroff – Wedbush

Can you give us a sense of how big each of the different product lines are? So for instance, approximately what percent of the business is LMS, what percent is performance? Can you give us a rough breakdown? What I am trying to do is I am trying to track the growth in terms of the newer products.

Bobby Yazdani

The way I would like to talk about it, is going back to the buyers, what we sell to that buyer. So if we have the learning buyers, we have essentially the performance management buyers/talent management buyer, which are different in many respects. And then there are the suite buyers, that buy the entire product suite.

So if you look at the last quarter, roughly about 10% to 15% came from essentially non-learning customers. We are seeing a very good level of business activity within our existing customer base taking up the additional products.

Michael Nemeroff – Wedbush

Have the customers – I mean, I understand that you want to create more of a suite-based approach, but have the customers been asking for the workforce management? Because it seems learning and workforce management are pretty far away from each other in the HCM cycle.

Bobby Yazdani

Not what we see from our end. We have our summit coming up in the first week of November and I asked our marketing people, what is the ratio of HR participants, which is the training participants. I was quite surprised at the level of participation from the HR.

Michael Nemeroff – Wedbush

What was that breakdown? What percentage?

Bobby Yazdani

I would say about 35%. This is a first for us. It is 30%, 35% participants out of the traditional training department. When I look at our customers, we have a European customer advisory board and a U.S. advisory board. The split is actually quite even now. You are seeing very good participation of either people who own the HR or the HR systems on the IT side, or the head of HRs who are participating in our advisory boards.

We have seen that consolidation not in the mid-market; we are seeing that consolidation starting to happen on the high end of the market.

Michael Nemeroff – Wedbush

As this transition happens, how are you compensating your sales people? Are you paying them extra to sign OnDemand business versus perpetual licenses? Is this something you are trying to foster or is it that you are paying the same amount and just letting the market dictate?

Bobby Yazdani

It is the same amount, we don’t prejudice one over the other, we really back into the customer needs. Our sales organization look at which solution the customer wants. They have in their bag the on premise offering or the OnDemand offering. This year we thought it was early for us to make that shift. This will be a key topic for Mike and I to discuss for next year.

Operator

There are no other questions or comments in queue. Please continue.

David Lebedeff

Thank you for joining us today for our first quarter conference call. We look forward to discussing our second quarter 2008 results that we will expect to report in early January.

TRANSCRIPT SPONSOR 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.

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Comments

[Frank Li:]

Looking at the company that sponsored this, turns out they compete with Saba:

Cornerstone OnDemand Announces Record Quarter

Leading Talent Management Provider Continues Momentum Through Q3

Santa Monica, CA – October 17, 2007 – Cornerstone OnDemand, Inc., the only proven provider of on-demand, integrated talent management software and services, today announced a record quarter for the Company. The Company’s sales increased 89% over the prior year and 128% over the prior quarter.

In addition, the Company opened offices throughout EMEA and hired seasoned executives Vincent Belliveau to run operations for the region and Sean Jacobson to drive global alliances strategy.

“The momentum for the business is palpable. Our marketing and sales operations are stronger than they have ever been, our sales pipeline is the strongest in the Company’s history, and our rising numbers reflect that success,” said Adam Miller, President and CEO of Cornerstone. “And with our recent funding, we have had the ability to rapidly expand our sales, international and channel operations.”

During the third quarter, Cornerstone closed two of the largest deals to date for the Company, one in the U.S. and the other in Europe, representing the addition of over 200,000 users to Cornerstone’s talent management suite.

In mid-September, Cornerstone announced significant new financing in the amount of $32 million. The capital is being used to substantially increase sales coverage, expand international operations, build global alliances, and accelerate on-going product development and marketing initiatives. The round was led by Bessemer Venture Partners and Bay Partners.

Cornerstone’s client acquisition continues to accelerate as the Company expands into new markets. The Company is recruiting in sales, account management, marketing and product development. For more information, visit cornerstoneondemand.co....

2007 Oct 17 03:19 PM