Mattersight Corporation (NASDAQ:MATR) Q4 2017 Earnings Conference Call February 14, 2018 5:00 PM ET
Kelly Conway - President and Chief Executive Officer
David Gustafson - Executive Vice President and Chief Operating Officer
David Mullen - Senior Vice President and Chief Financial Officer
George Sutton - Craig-Hallum Capital Group LLC
Eric Martinuzzi - Lake Street Capital Markets
Patrick Walravens - JMP Securities LLC
Good afternoon. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Mattersight Q4 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.
Mr. Kelly Conway, CEO of Mattersight Corporation. You may begin your conference.
Thank you. Good afternoon, everyone, and thank you for joining us today. With me today on the call and webinar are David Gustafson, our Chief Operating Officer; and Dave Mullen, our Chief Financial Officer. Before we get started with the content, I'd like Dave to share with you the Safe Harbor language. Dave?
Thanks Kelly. During today's call, we’ll be making both statements regarding historical facts and forward-looking statements, that are made pursuant to the Safe Harbor provisions of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934 in order to help you better understand our business.
These forward-looking statements are not limited to historical fact, reference our plans, intentions, forecasts, expectations, beliefs, strategies and objectives, and involve risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. The risks and uncertainties associated with our business are highlighted in our filings with the SEC, including our Annual Report filed on Form 10-K for the year ended December 31, 2016, our Quarterly Reports on Form 10-Q, as well as our earnings press release issued earlier today. Mattersight undertakes no obligation to publicly update or revise any forward-looking statements in this call. Also, please be advised, that this call is being recorded and is copyrighted by Mattersight Corporation.
Great. Thanks, Dave. Today, I will begin with an overview of our fourth quarter results, and then Dave will tell you how these results translated into our financials in Q4. We'll then review with you some key trends in our business, and in particular, what's happening with our predictive routing product and our go-to-market initiatives. Finally, we’ll finish up with our outlook for the full-year and then take your questions.
Turning to Slide 4, on the highlights for the quarter. First of all, we are quite pleased with our Q4 results. Right off the bat, we would like to highlight that we achieved record revenues and EBITDA in the fourth quarter. Secondly and quite importantly to us, PBR significantly contributed to these results in the fourth quarter. Let me highlight several of the ways. On top of the 4,000 seats we deployed in Q3, we deployed another 5,000 new seats in Q4. At the end of Q4, our routing installed base nearly doubled on a year-over-year basis.
And finally, our PBR revenues now approximate about 25% of our total revenues. Notable, we are starting to experience a benefit of the swing in our product mix towards our routing product. Here is some of the benefits. First, faster contracting and faster deployment times mean that we can turn opportunities into revenue much more quickly than with our legacy performance management products. In addition, the margin profile on our PBR products is much better than our other legacy products.
And finally, a key virtue of PBR is that due to its easily understandable ROI, follow on sales to existing PBR customers are happening much more quickly. I'll talk about this a little bit more detail later in the presentation. Another highlight is that we are pleased with the progress we are starting to make with our new logo engine, which is another topic I'll cover on later in the deck.
Finally, with respect to booking, they came in lower than we anticipated because we are unable to close several large deals that we continue to actively pursue and expect to close in the first half of 2018. The number of deals we are now chasing has never been higher, and I’m optimistic we can turn a number of these into contracts in the first half of 2018.
With that, I'll ask Dave to review our financial results. Dave.
Thanks Kelly. Let me attach some numbers to Kelly's comments. With respect to revenue, Q4 came in line with our internal forecast at $13.6 million. This represented a 9% increase over the fourth quarter of 2016. The sequential increase in revenue over Q3 was 20%, which is attributable in part to seasonality and in part to the deployment of new business during the quarter.
Subscription revenue came in at $12.8 million, a 12% increase year-over-year, a 21% increase sequentially and representing 94% of our total revenue for the quarter. As Kelly noted, routing or PBR accounted for 25% of that total. In Q4 of 2016, it was only 15%.
Bookings were $2.8 million, below our expectation as Kelly mentioned as several large deals pushed to 2018. Adjusted EBITDA was a positive $1 million, which was in line with our forecast. That result represents $0.5 million improvement over Q4 of 2016 and $1.3 million improvement over the third quarter of 2017.
We were able to put about half of the incremental revenue over last year’s fourth quarter on the EBITDA line, which I think is evidence of some of the operating leverage that we’ve been trying to unlock. At December 31, we had $8.9 million in ACV, or annual contract value, in our backlog that's expected to flow into revenues over the next four quarters.
If we turn now to Slide 6 with respect to revenue, you can see that 2017 is reflecting a similar trajectory to prior years. In addition to the standard chart on quarterly revenues that we traditionally include in these earnings presentations, we've added a slide to show trailing 12 months revenue, because the seasonality of our business sometimes obscures the progress that we're making. The slope of that curve is perhaps a little flatter than we would like, but I think it shows progress just the same.
At this point, I'm going to turn it back over to Kelly to comment on some of the key trends going on in our business.
Thanks, Dave. Turning to Slide 8, we now like to highlight the dramatic growth in our PBR business. Slide 8 shows our seat count trends over the last eight quarters. And as I mentioned earlier, PBR is really starting to drive a significant swing in our product mix. This slide shows the impact in terms of growth of our installed PBR base, since the beginning of 2016.
And as you can see, the deployed PBR seats are nearly doubled each of the last two years. In 2018, we expect PBR seats and revenues will continue this rapid onset, and it’s quite possible that these are PBR revenues could double yet again in 2018.
Going forward, we expect our new logo engine will play a more important part in driving our PBR growth. As we previously mentioned, we changed our strategy for new logo marketing at the beginning of 2017 to a much more targeted approach. I'm pleased to say we're starting to see some of the initial fruits of this change in strategy.
Following several dry quarters after we made this change, we added one new logo in Q3, prestigious Fortune 100 healthcare payer, one more in Q4, a very large financial advisory firm and already in Q1 to-date we've added two new additional logos. One, a very large financial services firm and the other in large business services company. While these initial deals in Q1, a relatively small, they represent the opportunities creates a significant expansion at both of those accounts.
We are of course very heartened by this progress. Our new logo pipeline is dramatically more robust than it was a year-ago and we remain very focused on improving the execution of converting these opportunities into bookings and revenues in an expeditious manner.
Now let's turn to Slide 9. Slide 9 highlights and calls out our PBR retraction and account expansion trends, which you see in this table is the summary for 2016 and 2017 and in the top row is our subscription retention and in the second row is our subscription retention when you add on upsells. These numbers are impressive.
As you can see in both years, we had very low attrition, in fact last year we had no attrition in our PBR business and we've experienced extremely high PBR expansion rates into existing accounts. Again that’s because of the clear demonstrable benefit that PBR drives, which is easily articulatable and quickly understood by our clients.
We are extremely encouraged by these trends and I think those of you are familiar with SaaS models can recognize that these are very impressive numbers and while it’s early, I think it highlights the strength of the PBR product, delivery and value proposition.
Finally, as a natural byproduct of our focus on PBR and our revenue mix swing, we are seeing some attrition in our analytics business, particularly in the areas of performance management as we resulting from our increased emphasis on PBR and relatively less emphasis on some of these other products.
With that, I would like to turn it over to Dave to wrap up the presentation part of the call.
Okay. Turning to our outlook for 2018, there are a number of factors influencing our perspective. First, as you've heard from Kelly, we continue to be enthused about the momentum we have in routing.
Routing could comprise close to half of our subscription revenue by the end of this year if we are successful. This is to offset somewhat by softness we see in our performance management business, where we expect some attrition including United HealthCare, who has informed us of intent to reduce the level of services they received from us in 2018.
We also expect to significantly improve our cost structure with some internal initiatives that we have underway, and this combined with the fact that routing has a more attractive margin profile than our analytics products leads us to believe that we can further streamline our operating expenses.
Until we start converting our pipeline into bookings more consistently, we will remain cautious about our topline growth. So with that intro, I'll say that for the full-year, we expect revenues in the range of $48 million to $52 million and we expect to be EBITDA positive for the full-year.
With that, I'll turn it back over to Kelly to wrap up.
Great. Thanks Dave. As you can see we are in the midst of a very significant revenue transformation driven by our very exciting PBR product, while at the same time some of our other products are selling some slowdown, but we think the overall picture is quite positive.
And with that, I'd like to turn the call open – operator to questions.
[Operator Instructions] And your first question comes from the line of George Sutton from Craig-Hallum. Your line is open.
Thank you. Hey guys. So first relative to the United HealthCare piece, my math would suggest that maybe that's a $3 million to $4 million impact, is that a reasonable assumption to make?
George, I don't think we’ll comment on the UHG forecast, let me give you some reasons why and some color on that. We operate at United HealthCare across multiple business units and multiple products. We continue to have a number of those streams are active in an active pipeline.
On the other side, we do see some cost pressure at United HealthCare. And with all of that said, we expect that United HealthCare will continue to be a significant customer in 2019, while at this point difficult to estimate the exact number that we're going to get from UHG. The combination of those factors has been reflected on our guidance, George.
Okay. I just want to update a couple of things from last quarter. You had in your pipeline, I think a very large potential new customer, significant number of new seats. I'm just curious if there's been any progress on that specific customer. And then I believe you also had a pilot that was going to start literally January 1 of about 5,000 seats, so I’m curious kind of what that’s been?
Yes. So let me take the second one first as it relates that pilot. That pilot has run very successfully. And while we think that it might be slightly lower than the 5,000 seats that it has been very successful and we are in commercial discussions with that customer on the conversion of that pilot.
We would be hopeful to be able to commence those discussions will close that deal in Q1, although, you can imagine that's a very large transaction. As it relates to the large customer, that customer continues to be out there and we continue to pursue that and we are hopeful that that will close sometime in the first half of 2018.
Okay. And lastly for me, relative to your vertical focus, you had identified the focus on the handful of verticals. And I think at the same time, you were talking about the number of active pursuits which were up significantly. Are the number of active pursuits, can you give us a sense of kind of how that's ranged? And then is that – is it still the five verticals that you're predominantly focused on and that you don't plan to change I assume?
Yes. We're focused on four verticals, George, I might have…
Well, I’m [going in] financial services, and I’m separating financial services and insurance, so if you put those together.
Okay. Fair enough. Then in that case five. We're still focused on those and I don't think I'm not in a position now where we could quantify exactly how much – what the specific increase has been. I will tell you that when I started a year-ago, the covered was relatively bare in terms of new logo opportunities that were being pursued by our hunters. All of them are pursuing pipelines with $10 million worth of opportunity today. So it's much better now.
You can talk about all the opportunities you want to. Our job is to convert them and I don't want to talk up the opportunities or rather talk up the conversions and we still have some work to do on that. But I think that we have many more opportunities and Kelly mentioned this in his comments that we are chasing them, we were chasing a year-ago.
Gotcha. Okay. Thanks guys.
[Operator Instructions] Your next question comes from the line of Eric Martinuzzi from Lake Street. Your line is open.
I have a question about the seasonality of the revenue this year. If we take the average of the past couple of years, I think we've seen that front half for Q1 is around 23%, 24% and then we finish out the year at about 28%, 29%. So the seasonality of the revenue is my question. Should we expect that to repeat?
We believe it will, Eric. The seasonality is a product of having a customer mix that includes a fair amount of healthcare and a fair amount of retail both of which have pronounced seasonality in the back half of the year in particular the fourth quarter. So we would expect that trend to continue in the foreseeable future.
Okay. And then that was the revenue question. The profitability, you gave color for the full-year, you expect adjusted EBITDA positive for the full-year. Translating that into – let me ask the same question, quarter-by-quarter, seasonality expectations for adjusted EBITDA?
Yes. I think that you will see a similar pattern to what you saw last year where the first and second quarters were breakeven, slightly negative and then the trend started to improve in the third quarter and it gets sort of fun in the fourth quarter. And again, I think we have an expectation that that would be a similar pattern in 2018.
Okay. And then just focusing in on the 2018 revenue growth, if I look at the midpoint of that expectation of $48 million to $52 million, we're talking about 7.5% revenue growth. What’s your – obviously, you’re working against some headwinds here within United HealthCare relationship, how would you characterize the overall market growth rate?
I think Eric you have to look at the two parts of the business. Our routing business should double again this year on a revenue basis. So that would be kind of three years in a row of 100% revenue growth. We're very pleased and impressed by that. We also believe that as the – particularly, we drive a lot of new logos with routing, it will reignite. So a couple things will happen as routing becomes a larger and larger percentage of our revenues of course that will drive a better growth profile overall, it just as that improves as part of the revenue mix.
And secondly, as we get into a number of new customers with routing, it drives significant demand for our analytics. And I think we'll start to see that in the back half of the year as we will start to book more new analytics projects. But those are PBR driven clients and so we're really moving our business to this PBR driven approach and I think the growth rate for that kind of when you strip out let's call it some of the legacy accounts is quite robust.
The issue that we have just mathematically, it's not a big enough part of the overall revenue mix to lift the whole board up. But it very well could be as you get into the later parts of the year to really start to see that impact. But those are the really the three factors that are going on.
PBR is growing explosively and we expect that to continue. As we get into new accounts of PBR, it's going to create many new analytics opportunities and we have seen that and are seen that. At the same time some of the legacy revenues are weak and that's what is kind of obscuring and clouding the picture that you're seeing Eric.
Eric, we’ve always had attrition. In years past, when we had attrition in analytics, we sold more analytics and that more than offset the attrition. Today our sales force is focused almost exclusively on routing and to the point where we don't really want to sell anything other than routing to a new logo because it's quick, it's easy, you can prove the ROI and new build credibility instantly, and then you do the follow on sale for analytics and we've found that that's a better go to market then historically. So when Kelly says that one part is going crazy, the other part is sort of not going crazy, it's because of where we're focusing our attention and that's a conscious effort.
I understand. Okay, as far as the cost structure, do you have any expectations that your headcount will grow during 2018 as you grow that revenue 7.5% at the mid-point?
It will, but let's just say, we've gone through an exercise of identifying sort of for the first time. When you're scrambling to please customers and to grow sometimes the cost structure that you put in place to do that doesn't occur you as a priority. We've now start to focus on it and we've identified substantial opportunities to streamline the way we deliver our services. And so I think you're going to see more modest revenue growth – more modest growth in operating expenses this year than we've seen in the past.
Okay. And then lastly, the large opportunity that you're going after here and we're hoping to close in the first half of the year, obviously there's a cost benefit to them pulling the trigger and signing and installing, but there's always the chance things could slip. If it were to slip out of the first half of the year what might be a reason that it would move to the right?
Yes, I think that would be a – right now what I can tell you is that we're driving a very significant reduction in their costs across a pilot group of about 600 people. We think that that is extensible across the 3,500 and 4,000 people that they have that we're targeting to roll this application out.
I think our client sees that. We're Eric at the point in time where we're starting to negotiate with them on the business terms. So we don't anticipate that we'll have a problem. It would be some – it would be an unknown at this point because they're very – they are pleased and convinced with the results. I think we've identified in general our market clearing price that works for them and is conversationally attractive to us. So we remain cautiously optimistic that this deal will get done because frankly the benefits of PBR are so darn compelling.
Understand. Thank you for taking my questions.
Your next question comes from the line of Pat Walravens from JMP Securities. Your line is open.
Okay, great. Thank you. So should we expect ACV to grow in 2018?
ACV, you mean backlog?
Bookings. Yes, we expected to book substantially more in 2018 than we did in 2017.
Okay. Great. And when did you find out about United HealthCare?
Well I think it's in the light of an ongoing account relationship that we have multiple business units and multiple products and some of them are clearly slowing down and I think we're seeing cost pressure and that has been relatively recent. The indications that these cost pressures are going to take a hit on our revenue, frankly just been in the early part of this year.
Okay. I remember a couple years ago, there was hope to double the size of those accounts, so I'm just wondering when that as this thing gradually getting less optimistic or…?
I think there's still a lot of opportunities in the United HealthCare. We're pivoting our business away from our traditional performance management. We're discussing a number of opportunities in division we are in around other products including routing as well as going into other divisions and having those discussions as well. So what I would say is there is a cross currency here, but we do expect the spending will be less in 2018 than it was in 2017 and we wanted to make sure that was highlighted and reflected in our guidance.
Yes. That’s good. And Kelly, how are you different than affinity?
I'll let David. David, you're on the line. I'm going to turn that over to you. You're closer to the product marketing teams.
Yes. Pat, as we've discussed a little bit in the past that that is the one other name we see out there is the closest competitor to our PBR products. We don't really run into anybody else, it has similar solution. In terms of the market and the opportunities, we do run into each other curiosity. But there is a lot of opportunity in that market given both of our penetration rates, so there's a lot of opportunities in places where we are, we don't run into each other. In terms of the differences, there is a couple, I think really important differences.
The first is, we believe we have a much more powerful dataset to pair and route callers. We have a dataset around customers communication styles and personality styles and how they want to be communicated on a phone conversations. What affinity leverages is publicly available, demographic data. So it's really not data around someone's communication styles and personality styles and behavioral characteristics.
What we found in looking at that dataset and then our dataset that we find that our data is much more powerful in terms of the predictive nature around dictated how our conversation is going to go, whether it's going to be shorter, the sales rate will be higher, the satisfaction rates, retention rates will be higher.
So we're able to drive significantly more benefit with the data that we have, that unique dataset that we've built relative to the data that's publicly available to consume for routing. We think that's probably the largest and most important differentiator because ultimately it gets to how value you can drive for your customers.
There's a couple other ones. We from a technical approach, we are a passive, adjunct route request or routing. So we don't take over and control the routing platform to allow the call. The primary approach by affinity is they're required to take over and actually route the call or queue the call. So it creates a bit more risk from a technical implementation perspective. Ours has less risk, in terms of the technical implementation.
And the third is we don't require a call center agents to take any sort of profiling or surveying with affinity the agents all need to take surveys in order to figure out how to handle the calls and we've heard from some customers and potential customers is that it creates a bit of a HR issue in terms of implementation. So I think those are the three main ones. Most importantly those is, I think our data is more powerful in terms of driving significant real benefit.
Okay, that’s helpful, yes.
Let me just add on to some additional data on that and the last four – and the four new logos we've added Q3 and Q4 in quarter to-date. Three of those they were not competitive, there was no other competitive issues or alternatives that were being reviewed by the client, in one case a very large financial services firm.
They added one probably about a year-ago or so looked at affinity and because of some of the issues that David mentioned particularly how they interfaced with the telephony infrastructure, this company passed and as a result of that that opportunity came to us. So largely right now, yes we do run into that from time-to-time, but largely it's a Greenfield market path.
Okay, great. Yes, just comes up because of the McKinsey thing. So that’s why I was asking. And so last one, I guess David for you, so if you look at the balance sheet, [indiscernible] $9 million in cash $17 million in long-term debt, how do you feel about that and what’s the plan?
We believe that if we execute on our plan path that we have sufficient capital to get to cash flow breakeven. We think that that number is around $15 million in quarterly revenue. We think $12.5 million is sort of EBITDA breakeven and $15 million is probably cash flow breakeven and we're not far off of that. We don't think we're going to use a lot of cash this year.
Having said that, we’re regularly evaluating the wisdom of getting more capital to try to accelerate our growth rate, and we continue to look at that. But if push comes to shove, we think we can make it with what we have. We have additional borrowing capacity in our line. And with PBR, our non-EBITDA cash needs have gone down fairly dramatically because we don't have the equipment investment that we typically have in analytics.
This is Kelly. Again, I would add to what Dave’s, as I think that if at some point – it’s appropriate to have additional capital. I think we're much more confident to deploy it. Those are really two reasons. One, our new logo engine starting to fire more effectively, I think we now know how to turn that crank, where we would spend that money, and I think we have a reasonable estimate of kind of what the returns would be for turning that crank. So that's really important as you know, Pat as you start to scale the SaaS businesses. I think we have a good sense of what the input, output machine is in a new logo engine.
Secondly, I think it's clear given the profitability in Q4 and the profitability outlook in 2018 that as if those revenues ramp, you can start to get significant leverage in this business, particularly if the mix shifts to PBR. So I think we're at that point that if we have the ability to turn that crank faster, it would be very interesting. We have to make sure we are able to do that and that's an appropriate thing to do. But I think those are very important points that we understand what the leverage of that of any additional capital might be, and we think it would be quite significant.
Okay. Great. Thank you.
There are no further questions at this time. I will turn the call back over to Mr. Kelly Conway for closing remarks.
Thank you. This is Dave. We got one question come in via a text channel and I just – I’ll read the question and maybe I'll ask David to answer it. But to what extent can you demonstrate an ROI from your newly patented functionality for Chatbot products? To what extent are you actively marketing it and what level of market and penetration do you anticipate going forward?
And I can handle that, Dave. So just to confirm in our press release, we did announce new patents around Chatbot functionality, but we did not announce new products around Chatbot functionality. We think the space has a significant opportunity in the future. As we eventually think about expanding our product line even further outside of PBR, the potential to have the Chatbot that recognizes your personality style, your behavioral characteristics and is able to change the way that it interacts with you based off all that data.
We think that's a really big opportunity and so we are doing research in the area. We are patenting that future opportunity for us to acquire that. We have some things in-house that we’re working on. We do not have a commercially launched product in that area yet. We are protecting the future opportunity for us to have that commercial opportunity or potentially to partner with a company that focuses more exclusively on Chatbots and leverage our technology together in a go-to-market strategy.
End of Q&A
Great. Thanks David. And again, thank you for your time and attention. We're very pleased with the results we posted in the fourth quarter with the record revenues and EBITDA, and we are extremely excited about the prospects for our PBR business and its ability to transform our business over the next few quarters. And we appreciate again your time and attention. Thank you very much.
This concludes today's conference call. You may now disconnect.