Business Context and Reporting Period
eGain Communications Corporation provides cloud and on-premise customer-interaction software for sales and service, including hosting, maintenance and support, licenses, implementation, consulting and training. The company operates in North America, EMEA and Asia Pacific. This unaudited Form 10-Q covers the three months ended September 30, 2011, the first quarter of fiscal 2012, compared with the three months ended September 30, 2010.
Financial Performance and Position
| Metric | Q1 FY2012 | Q1 FY2011 | Change |
|---|---|---|---|
| Total revenue | $10.4 million | $13.1 million | Down 21% |
| License revenue | $2.9 million | $7.4 million | Down 61% |
| Recurring revenue | $5.8 million | $4.5 million | Up 30% |
| Professional services revenue | $1.7 million | $1.3 million | Up 35% |
| Gross profit | $7.6 million | $10.6 million | Down 29% |
| Gross margin | 73% | 81% | Down 8 percentage points |
| Income from operations | $1.0 million | $4.9 million | Down 80% |
| Operating margin | 9% | 37% | Down 28 percentage points |
| Net income | $574,000 | $4.8 million | Down 88% |
| Diluted earnings per share | $0.02 | $0.22 | Down $0.20 |
| Net cash from operating activities | $4.3 million | $(600,000) | Improved by $4.9 million |
Recurring revenue comprised 56% of total revenue versus 34% in the prior-year quarter. Hosting revenue increased 38% to $2.6 million, and maintenance and support revenue increased 24% to $3.2 million. Professional services gross margin improved to 10% from 4%, while recurring-revenue gross margin improved to 78% from 72%.
At September 30, 2011, cash and cash equivalents were $15.4 million, up from $12.4 million at June 30, 2011. Working capital was $2.7 million versus $3.8 million at June 30, 2011. Deferred revenue increased to $7.0 million from $5.8 million. The balance sheet included $1.0 million of non-current restricted cash required under the Comerica facility.
Debt included approximately $4.6 million outstanding under the Comerica term loan and $5.1 million of related-party notes payable. No amount was outstanding under the $1.5 million Comerica revolving line. The company was in compliance with its debt covenants, including the $1.0 million minimum cash requirement and a 1.50-to-1.00 liquidity-to-debt ratio.
Material Changes Versus the Prior Comparable Period
- Total revenue declined primarily because the prior-year quarter included an approximately $7.0 million large license transaction, compared with approximately $2.2 million of major license transactions in the current quarter.
- The business mix shifted toward recurring revenue and hosting, which management described as producing more ratable revenue over contract terms but lower current-period revenue than a delivered license transaction.
- Operating expenses increased 15% overall. Sales and marketing increased 15% to $4.0 million, general and administrative expense increased 38% to $1.1 million, and research and development was essentially flat at $1.4 million.
- Stock-based compensation increased to $130,000 from $54,000. The company granted options covering 203,300 shares during the quarter.
- Operating cash flow improved substantially, principally because accounts receivable declined by $3.9 million and deferred revenue increased by $781,000. This improvement was partly offset by payments of accrued compensation and accrued liabilities.
- The company repaid the Oak Hill and related lender obligations in June 2011, partially repaid the CEO’s related-party notes, and replaced a portion of the related-party financing with the Comerica term loan. Remaining related-party debt was required to be repaid or converted to equity by the end of December 2011.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management expected total license revenue to increase in fiscal 2012, but cautioned that sales-cycle length, customer acceptance, seasonal buying patterns, foreign exchange and the hosting-versus-license mix could cause significant quarterly variability.
- Management expected recurring revenue to increase or remain relatively constant and professional services revenue to increase in future periods.
- Sales and marketing, research and development, general and administrative and professional-services costs were expected to increase in future periods, reflecting planned sales-team expansion, marketing and partner investments, and increased headcount.
- Management believed existing capital resources would support current and planned operations for at least the next 12 months, while noting that additional financing or debt-to-equity exchanges might be considered and might not be available on favorable terms.
- Key risks include competition, uncertain demand, lengthy sales cycles, rapid technological change, reliance on strategic and distribution partners, international operations and currency fluctuations, execution of the growth plan, retention of personnel, and the need to maintain adequate capital.
- A third-party claim by former customer LaQuinta Corporation seeking indemnification in a patent litigation matter remained ongoing after the company’s motion to dismiss was denied on September 29, 2011. Management did not expect the matter to have a material effect, but no clear potential liability amount was provided.
- The long-running IPO securities litigation had been dismissed by final judgment; the remaining appeal was determined to lack standing, subject to any successful further appeal. No liability was accrued.
- The company reported no off-balance-sheet arrangements other than operating leases and a co-location agreement, and no material change in contractual obligations from June 30, 2011.
- Management stated that disclosure controls and procedures were effective at the reasonable-assurance level as of September 30, 2011, with no material change in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the expected increase in fiscal 2012 license revenue materialized and whether the recurring-revenue growth offset the volatility of license sales.
- The status and terms of repayment or equity conversion of the remaining related-party debt due by the end of December 2011.
- Compliance with Comerica’s minimum cash and liquidity-to-debt covenants, and the scheduled amortization of the $4.6 million term loan.
- Whether operating cash flow remains strong after the one-time benefit from collecting accounts receivable and changes in deferred revenue.
- The outcome and potential financial exposure from the LaQuinta indemnification claim.
- The effect of increased sales and marketing investment, stock-based compensation and headcount on future operating margins.
- Customer concentration and revenue timing: one customer represented 18% of current-quarter revenue, while one customer represented 55% in the prior-year quarter.
- Foreign exchange exposure, as the company had approximately $8.7 million of identifiable assets denominated in foreign currencies and used no currency derivatives.