eGain Up 50% In A Day, What's Going On?
- This is a stock that is used to big and sudden jumps on earnings, but underlining growth is healthy.
- It's masked by a shift in business model towards a cloud based SaaS platform, its declining legacy business reduced headline growth.
- But business development is sound and the optical effect of the change in business model will wear off and the benefits will remain.
After a truly epic rally half a year ago, we wrote that the shares of eGain (NASDAQ:EGAN) were fully valued, and then they crashed. A few months later, we argued the crash was overdone, and now the shares are coming back, even if we had to wait for that quite some time.
eGain offers a cloud based customer engagement solution that stitches together all customers' touch points in a single solution and adds AI smarts and analytics to gain insights.
It started off as an on-premise solution, but the stock started to seriously take-off when the company moved towards a cloud based SaaS model. That's not surprising for anyone who is a regular reader of our articles here. We're great fans of these Swiss army knife-type business models.
We're hardly alone in that, witness the premium valuations companies based on these business models command in the markets, and eGain isn't an exception.
Here is a longer-term view:
You see a decline in revenues that has only started to reverse last year, but this is simply optical and the result of a shift in business model. The company used to sell on-premise license, but it has moved to cloud SaaS subscriptions.
In fact, so tiny are the license revenues (less than 1% of revenues) that the company is now reporting two revenue categories: subscription (89% of revenues, up 25% y/y) and professional services (11% of revenues, down 32% y/y).
The latter is due to the decline of its legacy business as legacy support is declining. Management expects this to continue during the year and professional services will constitute high single digits part of revenue in the second half of the year.
The most important metrics however are SaaS revenue (growing at 53% y/y in Q2) and subscription revenue (+25% y/y). Management argues that their remaining on-premise customers will have moved to the cloud by the end of 2020.
The cloud based SaaS models allows all the trappings of that business model which we have discussed in multiple articles here (see for instance here), like recurring revenues, adding features and partners and scaling.
The company has important partners in Cisco (CSCO), Avaya (AVYA) and Amazon (AMZN) Connect with the first especially important (Q2CC):
we saw healthy OEM bookings in the quarter through Cisco. Working with Cisco and the two teams, we have continued to enhance our OEM chat and email solution, which is embedded in Cisco’s enterprise contact center platform. With the latest iteration that we launched together late last year, it included some compelling features that we added to the OEM chat and email solution, based on that, the market seems to be responding well to the Cisco broad contact center offering. We are very pleased with the growing customer traction and ecosystem pool with this partnership and we continue to invest accordingly.
The Swiss army knife-like characteristics of SaaS platforms allow these to expand in many directions, adding new products and services, and the company's platform is no exception with new services like:
- Virtual Assistant
- Social (chat and email) with Cisco
With the VI and AI generating the most interest, their clients are overwhelmingly large - that is 90% or so is on the enterprise level with mid-market still under 10% of bookings but management also sees opportunities for growth in the latter segment.
In terms of sectors, the company is especially strong in financial services and healthcare.
Nicely summed up in the earnings PR:
- Total revenue was $17.7 million, up 15% year over.
- SaaS revenue was $11.9 million, up 53% year over year.
- Subscription revenue, which includes SaaS and legacy support revenue, was $15.8 million, up 25% year over year and 89% of total revenue.
- GAAP net income was $2.0 million, or $0.07 per share on a basic and diluted basis, compared to a GAAP net loss of $788,000, or $(0.03) per share on a basic and diluted basis, for Q2 2018.
- Non-GAAP net income was $2.4 million, or $0.09 per share on a basic basis and $0.08 on a diluted basis, compared to non-GAAP net income of $451,000, or $0.02 per share on a basic and diluted basis, for Q2 2018.
- Cash provided by operations in the second quarter was $863,000, compared to cash provided by operations of $2.6 million in Q2 2018.
- Total cash and cash equivalents as of December 31, 2018 was $11.2 million, compared to $11.5 million as of June 30, 2018.
This was of course a significant beat. Revenues were higher than expected by $1.42M or nearly 9%, but it has to be pointed out that there was a $900K seasonality in there that isn't going to repeat in Q3.
The bigger beat by far was that of non-GAAP EPS, which came in at $0.08 while a loss of $0.03 was expected.
The shift in business model has done wonders for margins with gross margin rising to 69% (up from 65% a year ago). It's no mystery (Q2CC):
The year-over-year increase in the overall gross margin reflects a combination of the benefits we’re starting to see on the scale and efficiency around our cloud operations and the growth in our high-margin SaaS revenue while our low margin PS revenue declines as a total of revenue.
Subscription revenue margins of 77% (up from 75% a year ago) are a multiple of gross margins on professional services (5%, compared to 19% a year ago).
The improvement in operating margin (non-GAAP it was 14%, up from 5% a year ago) is even considerably more pronounced.
There isn't much CapEx to speak off so operational and free cash flow are virtually identical and have improved with the change in business model.
Cash flow from operations was $863K in Q2 and the company used this to pay off debt by roughly $1M. As a result, its net cash position is now $6.2M, up from $3.5M at the end of 2017.
- SaaS revenue growth guidance is increased from +25-30% to +30-35%
- Subscription revenue growth is raised from +10-15% to +13-16%
Valuation really spiked in the peak earlier this year which seemed a bit overdone to us, but we think the company is in a better place right now. Analysts are still not wildly optimistic about coming profitability, from SA:
EPS is expected to be $0.06 this year falling to $0.04 in 2020, although we have a feeling these figures are not up to date.
The variable to look for is SaaS revenue, which is projected to grow 30-35% this year. Overall revenue growth (15%) will be lower as the company's legacy support revenues are still declining because of the shift in the business model, but that effect will gradually wear off as legacy support becomes an ever smaller part of revenues.
So the real growth rate is somewhat lower than the SaaS rate as this is boosted by the conversions from legacy, but these should be few already, so the company is really growing at 25%+.
The stock is sensitive to exaggerated moves and Friday's nearly 50% jump is no exaggeration. While results were considerably stronger than expected, they were flattered by a one-off seasonal effect.
Still, with the company producing nice growth, positive cash flow and earnings and debt reduction, we see some further upside ahead, although it's likely the stock has to digest the big jump a bit before moving higher.
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