Convera Corporation F4Q08 (Qtr End 1/31/08) Earnings Call Transcript

Convera Corporation (CNVR)

F4Q08 Earnings Call

March 27, 2008 8:30 am ET

Executives

Patrick C. Condo, President and Chief Executive Officer

Matthew G. Jones - Chief Financial Officer

Analysts

Edward Flynn - Trident

[Robert Waylon]– Aladdin Capital

[Jim Mullin]

Presentation

Operator

Welcome to the Convera Corporation conference call reporting financial results for the fourth quarter and year-end period ending January 31, 2008. (Operator Instructions) Participants in today’s call are Patrick Condo, Convera’s President and Chief Executive Officer; and Matthew Jones, Chief Financial Officer.

Patrick C. Condo

I’m Pat Condo, Convera’s President and Chief Executive Officer. Yesterday we issued a press release containing the financial results for Convera’s fiscal 2008 fourth quarter and year-end and three months ended January 31, 2008. Our call today will review those results.

Following our presentation, Matt and I will respond to your questions. If your question is not addressed on today’s call, please contact our Investor Relations Department at 703-761-3700.

And with that, I will turn it over to Matt to review our results.

Matthew G. Jones

Prior to addressing the financial results for the quarter and fiscal year ended January 31, 2008, I would like to cover the company’s Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.

The company’s remarks in today’s conference call may contain forward-looking statements that are subject to risks and uncertainties, including but not limited to, business and economic trends, our ability to continue funding net operating losses, our ability to manage our expenses in line with the anticipated business levels, our ability to develop, sell, deliver and implement our software and hosted services products, the impact of the delays associated with the development of highly complex products, our competitive strategy and the impact of competition, the impacts of reduced IT spending and lengthier sales cycles, our dependence on sales to publishers and government agencies, our dependence on technology license from third parties, the uncertainty of newly emerging technologies including the ability of the Excalibur offering to achieve market acceptance, general economic conditions affecting our industry and markets and other risk factors as set forth in the company’s Form 10-K Annual Report and our periodic filings with the Securities and Exchange Commission.

These risks could cause future results to differ materially from those expressed in any forward-looking statement made by or on behalf of Convera. All forward-looking statements are based upon information available to Convera as of the date of this presentation and Convera assumes no liability or obligation to update or alter such statements whether as a result of new information or otherwise.

On March 31, 2007 the company agreed to sell the assets of its RetrievalWare enterprise search business to FAST for $23 million. The company completed this transaction on August 9, with a total consideration received including $18.1 million of cash, $4 million of restricted cash held in escrow and the assumption of approximately $900,000 of liabilities related to the employees of the RetrievalWare business.

All revenues and expenses reported for the RetrievalWare enterprise search business through the close of the transaction and for the three months and fiscal year ended January 31, 2008 continue to be reported as discontinued operations in the statement of operations. The assets and liabilities of the enterprise search business continue to be reported as “held for sale” on the January 31, 2007 balance sheet.

Now to our fourth quarter and fiscal year ended results. As noted in yesterday’s press release, revenue for the fourth quarter of fiscal year 2008 increased by $163,000 to $280,000 when compared to the year ago period. Revenue for the fiscal year ended January 31, 2008 increased by $849,000 to $1.1 million when compared to the revenues for the fiscal year 2007.

At January 31, 2008, a total of 39 Excalibur supported websites from 24 different publishers are in production. As of today there are 45 Excalibur supported websites in production of which 10 sites are currently selling ads.

A single customer accounted for over 80% of the revenue generated during the quarter and 82% of the revenue generated during the fiscal year ended January 31, 2008. Two customers accounted for 98% of the revenue generated in the comparable quarter and fiscal year periods of fiscal year 2007.

Our Excalibur vertical search services are targeted providing the most relevant search information to these professional communities to increase loyalty, increase duration of user visits and increase traffic on the sites.

We expect revenues from vertical search business for the next several quarters to come from three sources. First are the contract minimum revenue amounts that we receive regardless of the advertising services provided. The majority of our early vertical search contracts have included minimum revenue amounts, but it’s important to note that not all of our contracts with publishers provide for these minimum revenue amounts.

Second, we will receive a percentage of the advertising revenue earned by these sites. Our contracts have revenue sharing based on the advertising generated net of the advertising commission at percentages ranging between 20% and 50% of the net advertising revenues earned by each site.

Third, we have introduced a new pricing model for vertical search that bases pricing on a per search basis instead of advertising share. Under this model revenues are based on the size of the publisher’s web index that we host and monthly query volume. This model guarantees a revenue stream for each search made in the vertical application.

To date, several of our customers are finding this model appealing and we believe that will assist us in moving our customers away from the pure revenue share deals and will provide a firm and more predictable revenue stream for our services.

We are also seeing more interest from customers for total search site, which will require us to interface with enterprise search applications run by the publisher. This pricing model makes accounting for vertical search activity simpler than in a revenue share model, and we believe that the majority of our customers will move towards this pricing model over the coming year.

The company can also generate professional services fees from customer website customization requirements such as training of staff, search engine optimization, website monetization consulting, website GUI development, vertical search site deployment and hosting services.

Now, turning to expenses from continuing operations, total expenses for the fourth quarter of fiscal 2008 were $7.8 million, of which approximately $1.6 million represented non-cash charges. This compares to $9.3 million of total expenses for the year ago period, of which approximately $1.4 million represented non-cash charges.

Total expenses from continuing operations for the fiscal year ended were $30.0 million, of which approximately $4.4 million represented non-cash charges. This compares to $47.8 million of total expenses for the year ago period, of which approximately $16.9 million represented non-cash charges.

The decrease in expenses from continuing operations between the fourth quarter and fiscal years ended January 31, 2008 and 2007 is largely the result of the company’s efforts to streamline its business expenses and to discontinue initiatives that were non-strategic to the success of its business plan. This led to lower overall staffing levels and compensation costs, lower marketing program costs, lower consulting costs and reduced levels of professional fees.

During the fourth quarter, we recognized the opportunity to decrease our costs without impacting the search performance or the redundancy of our hosting environment by making some changes to our hosting architecture.

In conjunction with this change the company terminated its hosting arrangement for its AT&T San Diego hosting center, incurring one-time charge of $749,000 and recognizing an impairment charge of $603,000 on the hosting assets that became idle as a consequence of this action. We believe that this effort will save Convera approximately $1 million on an annual basis.

The further development of the Publisher Control Panel has also aided in our efforts to streamline costs allowing us to support and launch a larger number of vertical search sites with a smaller staffing level in engineering and implementation.

As a measure of the current capacity of the Excalibur hosting environment, we believe we can serve the vertical search sites with approximately 200 trade publications of this average size at above industry level search levels without requiring any additional capital expenditures. We believe that the Excalibur hosting capacity can be expanded to support over 400 vertical sites for an incremental capital investment of approximately $1 million.

The loss from continuing operations for the fourth quarter of fiscal 2008 was $7.2 million or $0.13 per share which compares to a net loss of $8.6 million or $0.16 per share for the year ago quarter. The loss from continuing operations for the fiscal year ended January 31, 2008 was $27 million or $0.51 per share, which compares to a loss of $45.3 million or $0.87 a share for the previous fiscal year.

We expect to see further savings realized in the coming quarters as the full impact of our streamlining efforts become apparent. We’re estimating fiscal 2008 expenses net of non-cash items to be in the $12.0 million to $14.0 million range.

The income from discontinued operations from the fourth quarter of fiscal 2008 was $166,000, or nothing per share, which resulted from the favorable resolution of contingencies related to the RetrievalWare sale. The company lost $1.1 million in discontinued operations in the fourth quarter of fiscal 2007.

Income from discontinued operations for the fiscal ended January 31, 2008, was $17.9 million or $0.34 per share, which includes income of $20,000 from operating the RetrievalWare business in fiscal 2008 through the close of the sale to FAST in August 2007 and the $17.9 million gain recognized on sale. The company had income from discontinued operations in the comparable period of fiscal 2007 of $456,000 or a penny per share.

Turning to the balance sheet, as of January 31, cash and investments totaled $36.6 million. The increases in escrow, prepaid expense and other assets is principally due to the escrow for the FAST transaction, net of amounts due to the purchase price adjustment due FAST.

Equipment on the balance sheet is due to the acquisition of the AdMomentum platform in the first quarter of last year net of depreciation and the $603,000 impairment charge in the San Diego hosting equipment, decreases in assets held for sale and liabilities held for sale are related to the completion of the sale of the RetrievalWare business to FAST.

And decreases in accounts payable are attributable to the overall lower and smaller size of our cost structure as a result of our streamlining actions. All other components on our balance sheet are in alignment with the amounts previously reported in the prior period.

And with that, I’d like to turn today’s call back to Pat for his update on the Excalibur business.

Patrick C. Condo

Recent reports by eMarketer have indicated that online ad spending will increase 23% into this year despite all of the economic woes. Further, this report also indicates that search-based advertising will make up 40% of web ad expenditures and that the ability to effectively measure targeted advertising is of primary interest.

Recent reports from IDC also indicate that the growth in major search portals was approximately 23% last year, while growth in vertical media sites was close to 70%. All of these trends are manifesting themselves in the markets we are pursuing.

Our goal is to build the largest collection of professional user-based sites on the internet. We have chosen the business-to-business market as the first segment to attack. According to business-to-business trade analysts, there are over two million professionals in the United States and UK alone that are subscribers to business-to-business trade press who are also the target market for our vertical search systems.

As we gain momentum and launch vertical sites, we believe that the traffic could be in the hundreds of millions of searches per year based on hundreds, if not thousands, of sites.

The first phase of our plan is to target the top 50 publishers with an estimated 2,000 plus relative magazine titles that could be converted to search-based sites with subscribers totaling more than the two million professionals mentioned earlier.

We’re picking only those sites that have a very specific audience with high value advertising, as well as those that the publisher can cross-leverage with his print and conference business. We currently have six of the top ten and ten of the top 20 largest business publishers as customers today.

Our business model is to leverage the sale of advertising made by the publishers on the site as well as take advantage of our own ad serving capabilities and become a collaborative supplier of advertising. Our strategy for achieving this is well underway.

In addition to this, we have also introduced, as Matt indicated, a capacity-based model that insures Convera is paid for every search on the customer’s network. As the volume of searches grow the customer pays for each search.

A benefit to this approach is that it encourages the customers to combine as many sites as they can into this program and to take advantage of the search volume discounts that occur as the volume scales into the millions of searches per month. In this model, they keep all the advertising revenue while we get paid for every search.

This new model went into effect early in this quarter, and we have several customers who are in active discussions around this. The minimums that were instituted last quarter coupled with this new model, give us the ability to receive guaranteed revenue from every new site.

Last quarter and through March, we signed new agreements with the following companies: Informa; Perspective Publishing; Incisive Media; Vance Publishing Corporation; Advanstar Communications and F+W Publications. In addition, we recently announced that UBM SearchMedica has launched an additional seven health verticals in the US.

All told, through March, we now have launched 45 sites with 10 of those customers currently selling ads that are now on the sites, and have a substantial number committed to launch and place advertising on the sites over the next few months. For 2009 our goal is to have over 100 sites launched by year end, and we are forecasting that we will exceed 150 sites under contract through this fiscal year as well.

Today we have 30 unique publishing customers and expect to continue to grow that number during the year. We expect to increase all the metrics for the first quarter. We expect to further increase revenue as a function of the number of sites online, the advertising revenue from existing sites and the changes to our business practices.

In addition, we should also see revenue as a result of the new pricing program we recently established. We’re in active negotiations with several existing customers to extend both vertical search site agreements, as well for the first time, managing their existing sites as well.

This would enable the customer to combine the traffic from both sites into one and create greater revenue streams from advertising. Many of the customers in the pipeline today are interested in pursuing this strategy and we hope to have news shortly on a few of those accounts.

In parallel to acquiring new customers, we are also focusing on how to help existing customers monetize their sites. To that end, we are doing several things to first, drive traffic on existing sites. We have built and deployed syndication tools, downloadable tool bars and improved our social networking tools as well as developing new services, all aimed at increasing traffic.

And the publishers are doing several things as well to drive traffic. They are incorporating vertical search sites into their core strategy and marketing the site through their print publications, conferences, webinars, and by direct mail.

And finally, customers are looking to syndicate the search site through their existing properties and with partner sites to increase visibility, drive traffic and ultimately enhance revenues. Many of the customers coming online in the fourth quarter are showing rapid gains in traffic such as Canon PharmaLive.

And those in the last month such as the new UBM sites and the recently announced site under construction with Incisive, which has an existing five million unique users per month, traffic will grow substantially.

In fact, traffic has increased from 7.8 million searches in the third quarter to over 9.5 million in the fourth quarter, and we are on track to grow traffic into Q1 at a better than 25% rate. We are now rolling out our publisher portal system that will enable all publishers to self-publish and create verticals on demand with little or no support required from Convera. Version 2 is now deployed to customers and UBM recently utilized this to self-publish the seven new US verticals without Convera’s assistance.

In the near future, the Publisher Control System will enable customers to build verticals in less than a week, significantly shortening the time to market for sites. And as we simplify the process, our ability to expand into both existing and new markets increases without having additional costs. This innovation will allow us to grow our business considerably beyond where we are today. We expect that mid-year we will launch the third version of the software targeting a larger and broader audience.

In addition to the B2B market, we have also been approached and are now considering developing relationships with large business to consumer sites as well as existing web-based properties. F+W Communications is our first customer in the enthusiast market which has similar advertising rates as the business market. We’re also expanding into other European markets, particularly Germany, which has the largest publishing market in Europe.

We’re now focused on the following actions for this fiscal year, helping our customers drive traffic with our tools and services, acquiring more customers with the Publisher Control portal and launching more sites. In addition, with our new business practices of requiring minimums and the addition of the capacity based license, our revenue streams will begin to grow substantially from last year’s base.

The revenue coupled with the decrease in operating expenses that Matt mentioned will significantly decrease the time to achieve breakeven. And with over $35 million in the bank, we’re not anticipating any need to raise capital and have more than enough to see us through breakeven.

We believe we’re the only company that today offers this set of technical capabilities with an integrated suite of services. We believe that this offering is a principal differentiator when publishers are looking to purchase software to create a vertical search site. Ongoing development in the quality of the search and new services for site management and traffic generation will further distance us from the competition.

And finally, as our plan is taking shape, we’ve become engaged in many significant negotiations with companies that are looking at launching large-scale vertical portals with estimated volumes in the tens of millions of searches per year both in the US and abroad. As well as with companies that may offer us a broad based advertising inventory that we can plug into our rapidly growing business to business network of sites. Our success in closing these deals cannot be guaranteed, but we’re very optimistic regarding the results.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Edward Flynn - Trident.

Edward Flynn - Trident

In regard to the number of searches, the individual searches, that’s a complete different way of handling the business. Do you really feel that that’s the way for you to go at this point completely? Are you going to totally do away with the minimums?

Patrick C. Condo

No, no. Basically we’re offering really a second option to customers. So the first option is a minimum with an advertising share. And the second option is the ability for us to charge them as a capacity model where every search that gets served we are charging the customer for regardless if they sell ads or not.

Edward Flynn - Trident

Economically, that’s the better way to go?

Patrick C. Condo

It all depends. I think it’s an option that we discuss with the customer. If we feel that the first option is the best option, then we sit with the customer and go through it. But in some cases, we have customers today that have an existing network of sites where they already sell ads.

And we’re unable to tap into that because they don’t want to give us a share of ads they’ve already sold. So this gives us the ability to go and combine those sites with new sites and create a whole different revenue stream that we weren’t able to approach before.

Edward Flynn - Trident

There’s been different speculation in the past about the Googles or the Ciscos of the world or people like that looking at your company. When you get to a point where you have, let’s say, you’re breaking even or you have more or double the customers you have now. Do you think that these people might come around?

Patrick C. Condo

Ed, I think that the way to look at this business is that it’s all about traffic. And it’s all about highly qualified advertising and targeting those ads to the most likely customers to consume the ad.

And if you look at the network we’re building and if you look at our goals, if we can get to several hundred million searches on our network, and we’re targeting a network of professionals across a wide variety of verticals. I think that that is where a lot of these large portal companies are trying to go, but they’re unable to get there because they’re targeting such a broad horizontal market.

I think by targeting the verticals and building this network and increasing the traffic, and focusing it on each of these different verticals, I think it’s a great business.

Edward Flynn - Trident

Is there anybody else out there, any other company, that really is in the same space as you, competing directly with you?

Patrick C. Condo

No, there is not one company today that has built a platform like ours, offers a suite of services like ours and is focused on these professional domains as a broad-based way to build a network. There are certainly point players in segments, maybe health, maybe finance, but there is nobody that covers the entire breadth of capabilities or verticals that we do.

And it’s important to note that most of the people that are in the publishing business are not singularly focused on any one vertical. Almost every one of the top 50 publishers has a wide array of verticals that they offer, ranging from health and finance and legal and automotive, etc.

So, when you walk in and you can only offer one segment, you might be interesting to that business unit, but you’re not interesting to the total corporation who is trying to move all of their properties offline to online. And that’s what we offer, and that’s why we’re getting such great penetration into the largest accounts.

Operator

Your next question comes from the line of [Robert Waylon] - Aladdin Capital.

[Robert Waylon] - Aladdin Capital

I’m just trying to get some kind of a handle on what your models look like with your new pricing models. What a gross revenue projection on a typical account would be? I’ve been a stockholder for six years in the company.

Patrick C. Condo

There’s two ways to look at it. There are entry-level pricing regardless of whether you’re going to sell advertising and give us an advertising share or whether you’re going to go on the capacity-based model. And that entry point is roughly between $60,000 and $100,000 per customer per year.

In the advertising-based model, we expect that once you sell enough ads based on the percentage that we agree on, and exceed the minimum, you start to pay above and beyond the minimum. If you never sell enough ads to exceed the minimum, you can keep your site up, but you always pay the minimum.

In the capacity-based model, you pay per search. So you basically pay us a certain amount of money per search, and that’s a volume-based scale. So at one million searches, you might be paying us $0.5 million a year, and at two million you might be paying us close to $800,000 a year. And it continues to grow, so every time you add searches, you move up the scale and pay us.

And the beauty of that model is that the customer can then combine and mix and match any and all of his sites. But implied in that model is almost the same as the advertising-based model, because remember in the ad model we get 20% to 50% of the ad revenue by setting a revenue per search number we’re actually calculating that. And saying to the customer, we’re going to get the same revenue per search, only it’s going to be for every search, and it’s up to you to monetize the site.

You can sell your own advertising, you may already have a business partner, or you may not or you may have some other angle that we’re not aware of. But at any rate, the more searches that hit your site we get paid for every one. So in either case I would say this that the smaller customers would probably choose to start with the minimum of some number in the $60,000 to $100,000 range, but the larger customers are going to start at a much bigger number.

Operator

The next question comes from the line of [Jim Mullin].

Jim Mullin

The Convera stock that’s trading over in Europe, I believe it’s in Frankfurt. Is that the same class of stock that trades here on NASDAQ?

Matthew G. Jones

There’s only one class of stock that trades.

[Jim Mullin]

Is that because of the large publishing industry over in Germany, or did you do some sort of financing over there?

Matthew G. Jones

I’m not aware of the reason why it does, but we only have one series of stock that is publicly traded.

Jim Mullin

I’m seeing a lot of references to semantic search lately. How does that compare to the vertical search that you’re offering?

Patrick C. Condo

What we offer is a semantic search capability. It’s the ability to categorize and classify information based on concepts and ideas, and that’s all the discussions out there amongst Yahoo! and Microsoft and people like that about how the world is moving to a semantic network so that they can get better quality search results.

That’s what we’ve been doing, and that’s why our vertical search is of such interest to the parties that are buying into it because it is very accurate, it does determine what’s the most relevant. And it cuts down on the time it takes to find the information you’re looking for. So we’re right in the middle of that.

Operator

You have no further questions.

Patrick C. Condo

Thank you all for participating on the call and should there be any questions, please call our Investor Relations Department at 703-761-3700. Thank you.

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