Covisint Corporation (NASDAQ:COVS) Q3 2016 Results Earnings Conference Call February 4, 2016 5:00 PM ET
Ed Yuen - Investor Relations
Sam Inman - Chief Executive Officer
Enrico Digirolamo - Chief Financial Officer
Kyle Chen - Credit Suisse
Mike Casado - Pacific Crest Securities
Good afternoon and welcome to Covisint Corporation’s Third Quarter Fiscal 2016 Earnings Conference Call. The call will begin with comments by management, followed by a question-and-answer session. Today’s call is being recorded. [Operator Instructions]
At this time, I’d like to turn the conference over to Mr. Ed Yuen, Investor Relations for Covisint. Mr. Yuen, you may begin.
Thank you and good afternoon. With me today are Sam Inman, Covisint’s Chief Executive Officer; and Enrico Digirolamo, Covisint’s Chief Financial Officer.
Certain statements made during this conference call that are not historical facts, including those regarding the company’s future plans, objectives, and expected performance, are forward-looking statements within the meaning of the federal securities laws. These forward-looking statements represent our outlook only as of the date of this conference call.
While we believe any forward-looking statements we have made are reasonable, actual results could differ materially since the statements are based on our current expectations and are subject to risks and uncertainties. These risks and uncertainties are discussed in the company’s reports filed with the Securities and Exchange Commission. You should refer to and consider these factors when relying on such forward-looking information.
The company does not undertake and expressly disclaims any obligation to update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.
I would also like to note that we have posted our earnings press release and presentation on our Investor Relations website.
I will now turn the call over to Sam.
Thank you, Ed. Good afternoon, everyone, and thanks for joining us today. Enrico and I are here today to discuss our FY16 third quarter results. I’ll start out by making a few comments about the quarter, specifically where we’re meeting our expectations and where we are behind. After my remarks, Rico will discuss our financial performance during the quarter in some greater detail.
Over the past 18 months, we’ve made considerable progress toward improving our operations and focus of Covisint, taking it from a department inside a larger company to a standalone public company.
For the third quarter, we once again met our quarterly revenue objective, finishing at $19.2 million. In addition to that, we continued to make excellent progress in improving our margins, which increased to 58% this quarter from about 40% last year. And our cash flow was much better than we forecasted.
So our work on exiting unprofitable businesses and the implementation of our new certified services partner strategy is bearing fruit and our cash position remains strong, as we finished the quarter with $38 million of cash on our balance sheet.
Despite achieving our top line revenue objective, this quarter did not meet our expectations, as the mix of our revenue was unacceptable. We finished with only $15.3 million of subscription revenue, which is substantially below our expectations.
Our sales execution, both our direct sales force and our partners’ was less than expected. We did close several important deals in the third quarter, including our announced partnership with a leading European auto manufacturer. But again this quarter, we’re not able to close a new agreement with Cisco, which had a significant impact on subscription revenue in the quarter.
As importantly, we were not able to close on any other significant deals in our pipeline that could have in fact covered the shortfall created by the lack of the Cisco agreement. Consequently, our subscription revenue in the third quarter is flat when compared to last quarter. We are simply not executing as we expected.
I remain confident that the changes we’ve made in retooling the company, its new strategy and direction, building the right leadership team, our sales approach of selling both direct and with partners is all the right strategy. The transition required in our company is simply taking longer than I planned. So based on where we stand, we’re adjusting our subscription revenue guidance for fiscal year 2016. We now expect revenue to be flat to negative 5% versus last year.
While our performance in growing subscription revenue has not come as we have expected, we do in fact continue to make excellent progress in other elements of our transition. Specifically, let me highlight our work on our platform.
Our work here continues unabated as we continue to enhance our platform to meet and lead the demands of the market. We have made much more progress in a shorter period of time than anyone expected. Of note, last quarter, our platform handled a record level of transactions.
The fall IoT release that I discussed last quarter has been extremely well received in the market both by our customers and our partners. We continue to receive high grades from a number of constituents for the platform’s technology features and its overall capabilities.
Our development team has successfully taken what was an excellent closed architecture platform and remade it to an even better open architecture cloud platform with hundreds of new APIs. Our new user experience and real-time analytics framework enables developers both internally and our customers to quickly build IoT applications like dash boards alerts, geolocation tracking.
Additionally, our new IoT device plug-in framework makes it faster and easier to integrate and connect things to our platform. These functions are industry-leading and are the foundation for making the Internet of Things a reality for our customers and in the market.
In addition, our Covisint Anywhere initiative continues with the expansion of the platform into new datacenters both in China and in Europe, thus providing a much higher level of flexibility for and responsiveness to our global customers.
We’re also pleased with the progress we have made in redefining our brand and positioning the Covisint cloud platform. Aaron Aubrecht and his team in our San Francisco office have given the company new visibility with industry analysts, all of which is critical to increase the awareness of our product to generate new leads and to capture new customers. It’s all very good work and we have more work to do here.
With those comments, I’d like to turn the call over to Rico, who will take you through our third quarter financial results in greater detail. Rico?
Thank you, Sam. Turning to slide 4 in the deck, the left side of this chart represents a pro forma non-GAAP financial overview of key statistics for the third quarter of fiscal 2016.
Just to remind everyone, the non-GAAP presentation excludes the impact of stock option compensation expense, increased research and development spend as a period expense versus the GAAP approach, which capitalizes a portion of R&D. The GAAP P&L, the reconciliation of non-GAAP measures to the most comparable GAAP measure were included in the press release.
During fiscal third quarter, we delivered total revenues of $19.2 million. Subscription revenues finished at $15.3 million, a decline of 3% versus last year. It is important, however, to review the year-over-year comparison in order to better understand the underlying results of the business.
Q3 fiscal 2015 subscription revenue included about $2 million of business that we have since exited. And as we’ve noted on prior calls, we replaced that revenue with new higher-margin business. Accordingly, a more appropriate description would be to compare our current results against the same set of businesses a year ago, which would then imply a third quarter year-over-year underlying growth of about 9% for subscription revenue on a comparable basis. For the first nine months of the fiscal year, that same comparison would yield underlying growth of 9%.
Subscription revenues represented about 80% of our total revenues for the quarter. Services revenues declined year-over-year to $3.9 million, in line with the plan we undertook a year ago. It is important to note that this quarter’s services revenue included a one-time event that brought $1 million of revenue in the quarter. It also brought $1 million of cash in the same quarter.
For the quarter, we delivered non-GAAP gross margins of 58%, a sizable improvement of a year ago when non-GAAP margins were 42%. This was driven by the gains we have made in the past year and our ongoing expense reduction program, particularly in the services expense area as well as our strategic shift out of lower margin pieces of our subscription business which I already described above. As a result of this improved customer mix, subscription margins continue to be where we want them to be.
We finished the quarter with $3.8 million non-GAAP net loss, an improvement versus a year ago when we incurred a $4.3 million non-GAAP net loss, as non-GAAP operating expenses were reduced in line with our plan.
We finished the quarter with $38 million of cash, a bit better than our expectations. Free cash flow burn defined as net change in cash in operating and investing activities for the quarter was about $5.4 million. Again, a bit better than our expectations, reflecting the one-time payment I mentioned earlier.
The bottom right of this slide provides our outlook and expectations for fiscal 2016. Our guidance is based on current market conditions. As Sam already noted, we will change our full-year guidance for fiscal 2016.
We now expect year-over-year subscription revenue to be between flat and a decline of 5% versus last year. When you adjust this guidance to reflect the businesses that we have exited, the underlying growth would be roughly 9%.
For fiscal 2016, we now expect services to be between 15% and 17% of total revenue. Putting it altogether, out total revenue guidance for the year will come down by about $4 million or about 5 percentage points.
With fiscal 2016 subscriptions revenue becoming a larger portion of our overall revenue, we expect non-GAAP gross margins to be between 55% and 60%. We expect to finish the year with a net loss of between $17 million and $19 million on a non-GAAP pro forma basis.
Recognizing the continued investment in sales, marketing and product management that we outlined in the last few calls, we expect our free cash flow burn of about $14 million to $17 million negative for the year. Finally, we expect our shares outstanding at the end of the fiscal year to be 40.4 million.
With that, I’ll turn the call back to Sam for closing remarks.
Thank you, Rico. So to summarize, we continue to make progress in achieving our strategic objectives, albeit at a slower pace than we initially planned. While we’re very pleased with our progress in improving margins and reducing cash burn, overall, we are disappointed with our third quarter results.
It is imperative that we continue to focus on closing opportunities, both with existing and new customers, using both our direct sales organization and our strategic partners. In fact, our product is strong and getting stronger as evidenced by the new market-leading functions and the reception I noted earlier from the market. And we continue to invest in product marketing, especially in training our new team and supporting their sales efforts.
The Covisint platform is instrumental in transforming the way enterprises do business. We see the growing market demand with our customers and with our prospects and we continue to believe there is a tremendous opportunity ahead for our company.
With those remarks, I’ll turn the call back to the operator to open the lines and let Rico and I take any questions you all should have.
[Operator Instructions] Our first question is from Kyle Chen of Credit Suisse.
Sam, relative to the subscription underperformance in the quarter, can you give us some incremental color on the execution shortfall, was it related to deal push outs, reduction in the demand environment, is it the macro competitive losses or did more customers get stuck in pilots and not moving to full implementations as you were previously expecting? Any details there would be appreciated.
It is, in all cases, our inability to decide and see how long it will take us to get our customers from initial interest through the pilot phase into production and contract. At the same time, Kyle, we’ve got a large amount of our sales force is new and so we continue to work with the help of our marketing team on giving them deliverables and support, right, and these opportunities and it’s taken us a while to get some of these new sales reps up to speed as well.
So it sounds like these aren’t lost deals, but more just delays and potential push outs?
Yes. Kyle, let me add some color to that. As you know, we’re selling these things at fairly large transaction deals. The deal we referenced that we closed over in Europe with an auto manufacturer, this is a big contract. And so you have to have a business need which takes time to find the right people and the line of business side that need a solution and then we translate it over with our friends and partners in IT. It makes for a complex sale. We always knew that; we thought maybe we can move through these pilots faster. So most of them are stuck in pilot phase, like you asked.
And then with the $4 million to $5 million reduction in the implied Q4 subscription guidance, it seems like we’re sort of de-risking and not really expecting much contribution on an incremental basis in the fourth quarter?
That’s right. I mentioned particularly disappointing to us is I have not been able to close the new agreement that we had talked about even last quarter with Cisco. That’s a fairly large piece of our immediate subscription revenue that’s missing. And I feel uncomfortable forecasting that in the fourth quarter.
And I guess just relative to Cisco, obviously they announced the acquisition of Jasper Technologies yesterday. From your perspective, is there any product overlap between Covisint and Jasper’s portfolio and wondering if we can get your initial impressions on how this acquisition could impact Cisco’s intentions in this space and how it can impact your relationship with them in their go to market strategy?
I think it improves and in fact demonstrates Cisco’s commitment to making that change in the basic nature of their business. We know Jasper and Jasper is a great addition to their portfolio because these are the guys working on the Internet of Things side, right, and the apps that connect information or to collect information, where, as you know, the platform that connects all that gets the right information to the right people at the right time, right. So it’s very complementary. I like the fact that Cisco is shifting their investment moneys now towards things that are in the IoT cloud space. I think it’s good.
So I guess in theory does it make them more competitive in the IoT space which could potentially create new opportunities since you’re attached to them?
Rico, quick question for you. Given the change in investor sentiment and appetite relative to unprofitable software companies, you could have done a pretty good job from an OpEx and cash flow perspective. Just wondering if you’re comfortable drawing a line in the sand anywhere and providing some profitability and cash flow breakeven targets?
We’re not ready to do that just yet, Kyle. As we work our way through the fourth quarter, at our next call, we’ll provide some guidance on fiscal 2017. We’ll be in a better position to walk our way through that and throwing some targets out there with respect to the topics you just mentioned.
The next question is from Rob Owens of Pacific Crest Securities.
This is Mike Casado for Rob. I wanted to ask about the Tech Mahindra partnership. How would you guys characterize the performance of that partnership? Have you found them to be expanding the use of the platform or what would you say about that?
I think it’s excellent. I think it patterns almost exactly the challenge that we’re seeing that we just talked about with Kyle in our direct sales force. Partners like Tech Mahindra and VisionIT have been excellent in getting us engaged with them in new opportunities. And as you know, a lot of their opportunities that they are now attacking for enterprise level identity and access management, IoT, they are new opportunities to them as well.
So we’re working together for them to learn more about our platform to be better skilled at selling and supporting our platform. But I have no complaints at all, in fact I’m very pleased with the activity. But I think it looks like us, it looks like they’ve got great opportunities, they believe they can close them and most of them, as Kyle asked, are just pilots and they are taking longer than we thought.
And then you mentioned the broad sales execution challenges, how is the progress in the build out of that new account exec team? Are you guys finding the type of talent you need? Is the shortfall there? And generally the progress on getting them up to speed, I know you said that that’s been a challenge. But relative to last quarter, what incremental color do you have on that?
The ability to find them has not been a problem. We’ve had a good hiring success in finding enterprise class sales executives. There is two things and let me reference this, the transaction that we did announce [indiscernible] what we want to do going forward over in Europe. That was a six to eight month cycle for a new rep, who he was, an outstanding account exec, we pulled in, took him six to eight months to get up to speed and that’s what we’re finding.
And then, of course, you add time to that along the way to find a business need translated to a solution that we support go through the pilot and so forth and so on. So I think relative to guidelines for you, it’s taking us a good eight months to get the kind of reps up to speed. We’re finding good quality people, it’s taken longer than I would have guessed a year ago to get them up to speed and more importantly find these big opportunities, size them with a line of business executives, get IT support, take them to a pilot and get him to where we’ve got a contract. So I just misjudged that cycle time.
And then I guess following up on that European agreement, what do think was the most compelling aspect of your platform’s value proposition for that auto OEM partner?
It’s like a lot of what we’re seeing, Mike, and we’ll spend some more time talking about FY17 as Rico said next quarter. We’re tuning the way we do this. We’re seeing a lot of good enterprise class access management opportunities. That oftentimes what I call the point of the arrow that the customer and the line of business sees as a problem and then of course the strength of the rest of our platform is a job for us to sell and that’s what we go through and then we close, right.
[Operator Instructions] Ladies and gentlemen, at this time, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.
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