Earnings Call Transcript - EGAN Q2 2023

Operator, Operator

Good day, and welcome to the eGain Fiscal 2023 Second Quarter Financial Results Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the call over to Jim Byers of MKR Investor Relations. Please go ahead.

Jim Byers, MKR Investor Relations

Thank you, operator, and good afternoon, everyone. Welcome to eGain's fiscal 2023 second quarter financial results conference call. On the call today are eGain's Chief Executive Officer, Ashu Roy; and Chief Financial Officer, Eric Smit. Before we begin, I would like to remind everyone that during this conference call, management will make certain forward-looking statements, which convey management's expectations, beliefs, plans and objectives regarding future financial and operational performance. Forward-looking statements are generally preceded by words such as believe, plan, intend, expect, anticipate or similar expressions. Forward-looking statements are protected by safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to a wide range of risks and uncertainties that could cause actual results to differ in material respects. Information on various factors that could affect eGain’s results are detailed in the company's reports filed with the Securities and Exchange Commission. eGain is making these statements as of today, February 14, 2023, and assumes no obligation to publicly update or revise any of the forward-looking information in this conference call. In addition to GAAP results, we will discuss certain non-GAAP financial measures such as non-GAAP operating income. The tables included with the earnings press release include reconciliation of the historical non-GAAP financial measures to the most recently comparable GAAP financial measures. Our earnings press release can be found by clicking the press release's link on the Investor Relations page of eGain's website at egain.com. Along with the earnings release, we have also posted an updated investor presentation to the Investor Relations page of eGain's website. And lastly, a phone replay of this conference call will be available for one week. Now with that said, I'd like to turn the call over to eGain's CEO, Ashu Roy.

Ashu Roy, CEO

Thank you, Jim, and hello, everyone. We delivered another quarter of record revenue. Our total revenue was $25.6 million, up 15% year-over-year in constant currency and exceeded our guidance and consensus estimates. Our SaaS revenue grew 18% year-over-year in constant currency. And we generated strong cash flow from operations in the quarter of over $7 million. Turning to business highlights, let me share some notable customer expansions in the quarter. First was a significant expansion with a leading healthcare services provider as they continue to digitally transform their business. The second was with a global provider of specialty insurance products as they are driving more cloud adoption. The third one was with a multinational retail bank in Europe. The last one I want to mention is with a fast-growing insurance company that's technology-first and has adopted eGain Solutions as their customer engagement hub. Our focus on stabilizing client retention, especially in Europe and our continued expansion with clients is showing results. Moving to an exciting product update. This past week, we announced the general availability of eGain Instant Answers. This first-of-its-kind capability enables knowledge users to find relevant answers and attributable responses by tapping into enterprise content repositories using generative AI technology like GPT. We've been trialing Instant Answers since late last year and it's been a hit with our limited release plans. Because the solution addresses an outstanding pain point in knowledge management: how to deliver relevant answers with minimal knowledge curation effort in the business. We are the first in the knowledge management market with such a solution. We are especially excited because we believe this approach presents breakthrough automation opportunities when combined with critical attributes our platform offers, and this is key. Attributes like compliance, analytics, design experiences, and more, so bringing this new technology around generative AI and combining it smartly with all the required critical attributes for enterprise knowledge management is what we think delivers a solution that is going to be consumable, safe, and responsible. Thanks to our composable architecture, we can quickly incorporate new technologies as they become available. And so given the trajectory of this disruptive technology, we are bullish about marshaling it and using it to drive user-friendly automation. Looking at the market and our overall business, market demand remains high for our knowledge-powered customer engagement offering. New inbound interest continues to be steady with more opportunities in our sweet spot of large B2C businesses, focusing on customer experience improvement and service cost reduction. As we know, Gartner's top technology recommendation for customer service and support leaders continues to be investment in knowledge management tools. We also know the market penetration for knowledge management tools is still low according to Gartner's assessment, between 5% and 20% of the market. So now, with our comprehensive solution, we believe we have the best solutions for this market need and we are confident that this need around knowledge management will become increasingly mission-critical in enterprises. At the same time, in the current environment, we continue to see sales cycles strengthening. Buying decisions are slowing down, due to cautious spending and careful reconsideration of priorities. Given these longer sales cycles and the fact that we are focusing on enterprises, we are refining our direct sales model, so we're hiring more seasoned sales professionals versus having a larger number of junior team members. In parallel, we are maintaining marketing around brand leadership, highlighting customer success, and ecosystem expansion. In fact, our next scheduled customer success webinar is with one of our marquee clients on February 28. With the strength of our balance sheet, we intend to maintain a healthy level of sales and marketing investment, so that we are well-positioned to capture market share as business conditions improve. In summary, we delivered another quarter of record revenue with strong cash flow. We continue to see a large market opportunity for our knowledge-led offering. We continue to innovate and improve our offering with innovation like Instant Answers as we lead the market in delivering solutions, our technology, and AI for customer engagement. New inbound interest remains steady even in this environment. So, we are continuing to build our new business pipeline. We're refining our sales model and hiring more seasoned salespeople focusing on enablement of the team and sales productivity. And finally, with our strong balance sheet, we intend to maintain a level of sales and marketing investment that allows us to be well-positioned as business conditions improve. With that, I'll ask Eric Smit, our Chief Financial Officer, to add more color around our financial operations.

Eric Smit, CFO

Thanks, Ashu, and thanks everyone for joining us today. Let me share some financial highlights for the quarter before getting into our outlook and guidance for Q3 and fiscal 2023. Total revenue for Q2 was a record $25.6 million, up 11% year-over-year, or 15% in constant currency, and up 3% sequentially from Q1. SaaS revenue was $23.4 million, up 15% year-over-year, or 18% in constant currency, and up 4% sequentially from Q1. Legacy revenue in Q2 was down to just 185,000 and accounted for less than 1% of total revenue in the quarter. When looking at revenue by region, North America accounted for 77% of total revenue this quarter, up from 73% in the year-ago quarter. Total revenue from North America was $19.8 million, up 18% year-over-year, whereas total revenue from Europe was $5.8 million, a decrease of 8% year-over-year. Looking at non-GAAP gross profits and gross margins, gross profit for the second quarter was $19.3 million, up 7% year-over-year for a gross margin of 75%, compared to 78% for the prior year quarter and 76% in the preceding first quarter. Now turning to operations, non-GAAP operating costs for the second quarter came in at $17.3 million, compared to $14.8 million in the year-ago quarter and $17.5 million in Q1. Given the current macro conditions and lengthening sales cycles, we continue to refine our direct sales model, as Ashu mentioned, hiring more seasoned sales professionals versus having a larger number of junior team members. We continue to maintain a level of sales and marketing investment given the large market opportunity that we see. Looking at our bottom line, non-GAAP operating income for the second quarter was $2 million or an operating margin of 8%, compared to an operating margin of 14% in the year-ago quarter and up from 6% in the preceding first quarter. Non-GAAP net income for Q2 was $1.7 million or $0.05 per share. This compares to non-GAAP net income of $3 million or $0.10 per share on a basic $0.09 per share on a diluted basis in the year-ago quarter, and adjusted EBITDA margin for the quarter was 9%, up from 6% in the preceding first quarter. Turning to our balance sheet and cash flows. Cash flow from operations for the quarter was $7.4 million, a 29% operating cash flow margin. Our balance sheet remains very strong. Total cash and cash equivalents at the end of the quarter was $80.9 million, up 18% from a year ago. Now turning to our customer metrics, consistent with our focus on selling to large B2C businesses interested in knowledge management to improve customer experience and reduce service cost, the number of $1 million ARR customers increased 21% year-over-year. Our average revenue per customer of $480,000 was up 20% year-over-year, and our Knowledge Hub now makes up approximately at least 50% of our total sales ARR. Turning to our LTM dollar-based SaaS retention metrics. For the quarter, the total number came in at 105%, as compared to 112% a year ago. On a sequential basis, we saw an improvement from 103% in the first quarter. Looking at the retention rates by region, retention and expansion within our U.S. base continues to be healthy, with a slight improvement in NRR in the quarter to just over 110%. In Europe, the number was still below 100%, but we also saw a slight improvement quarter-over-quarter as the customer base in Europe has stabilized with no additional significant reductions in the quarter. However, the losses we discussed last quarter will begin to impact our revenue in Q3. Our SaaS ARR excluding OEM increased 12% year-over-year, and looking at our RPO, total RPO increased 3% year-over-year to $92.2 million. Before moving on to our financial outlook and guidance, I'd like to highlight a few items that we've taken into account when determining our guidance for the third quarter. First, with the current strength of the U.S. dollar to the pound and euro for comparison purposes, we are also providing revenue estimates on a constant currency basis to provide better visibility to the underlying business trends. In addition, as we experience every year, there are two fewer days in our fiscal third quarter than in the second quarter, resulting in approximately $400,000 in less revenue. In addition, our second quarter revenue benefited from a significant uptick in seasonal volume that accounted for approximately $1 million in revenue that we do not anticipate recurring in our fiscal third quarter. And finally, the loss of the EMEA customers we discussed last quarter will reduce Q3 revenue by approximately $800,000. With that said, for the third quarter of fiscal 2023, we expect total revenue of between $23 million to $23.5 million. Adjusted for constant currency, we expect Q3 total revenue of between $23.5 million to $24 million. Turning to the bottom line for Q3, we expect a GAAP net loss of $1.2 million to $1.6 million or $0.04 to $0.05 per share, which includes stock-based compensation expense of approximately $1.6 million in depreciation and amortization of approximately $125,000. We expect non-GAAP net income of breakeven to $400,000 or zero to $0.01 per share, and the weighted average shares outstanding are expected to be approximately $32.1 million for the third quarter of fiscal 2023. For the full-year fiscal 2023, given the current economic environment, with timelines extending for deals to close, we are revising our previously provided guidance. So for the full fiscal 2023 full-year ending June 30, 2023, we now expect total revenue of between $97 million to $99 million; adjusted for constant currency, that could equal $100 million to $102 million. Non-GAAP net income of $4.3 million to $6.3 million or $0.13 to $0.20 per share; a GAAP net loss of $700,000 to $2.7 million or $0.02 to $0.08 per share, where we estimated share-based compensation expense of approximately $7 million for the year and depreciation and amortization expense of approximately $600,000. Our currency conversion rate assumptions are as follows: for Q3 ‘23 and the remainder of fiscal ‘23, we are assuming USD to British pound of $1.20 to $1, which compares to Q3 ‘22 when the USD to GBP rate was $1.34 to $1, and for fiscal year ‘22, when the USD to GBP rate was $1.33 to $1. So in summary, we delivered record revenue and strong cash flow in the quarter. While sales cycles continue to lengthen in the current environment, market interest in knowledge-powered customer engagement remains high. We have made adjustments to our sales team by focusing on enterprises and refining our direct sales model, hiring more seasoned sales professionals versus having a large number of junior team members. But with our strong balance sheet, we plan to maintain the level of sales and marketing investment that allows us to be well-positioned as business conditions improve. Lastly, on the Investor Relations calendar, eGain will be presenting a meeting with investors at the Annual Roth Conference taking place March 13 and 14 in Dana Point, California. We will be providing more details as we get closer to that date and hope to see some of you there in person. Also, we are going to be doing a virtual product demo at the end of March, where we will be highlighting the attributes of our new instant answers features that Ashu spoke of, as well as our broader knowledge management offering. We will provide more details on that event in the coming weeks. This concludes our prepared remarks.

Operator, Operator

We will now open the call for questions. Our first question comes from Richard Baldry from ROTH Capital. Please go ahead.

Richard Baldry, Analyst

Thanks. Could you talk a little bit more about the changes in the sales teams? Was this a proactive effort to sort of weed out underperformers and replace them with more seasoned reps? How is that effort going to find those people? Is that easier given the layoffs we're hearing about in the tech space? Or is it still challenging to find the right people?

Ashu Roy, CEO

Yes. Richard, this is actually a combination of both proactive efforts and performance management. We had initially intended to scale up the sales team quite significantly. And then as we started to look at enablement and productivity, we felt it was important to manage performance among some of the team members, which is one element that we continue to do. The other is that as we are seeing opportunities coming more from larger enterprises, we feel that it’s beneficial to upgrade some of the team to more seasoned sales reps. So that's part of our strategy, and driving performance management from the bottom is vital.

Richard Baldry, Analyst

Great. And can you talk a little bit more about the generative AI technology piece for the Instant Answers? Will that add on to what you have or will it be standalone? I didn't catch quite quickly enough. Is that an embedded version of what a ChatGPT is or is it just similar to that type of technology, but something you've built on your own? And how do you see the economics of an offering like that being similar to what you've done in the past or different depending on sort of technologies embedded in it that might have higher costs? Thanks.

Ashu Roy, CEO

Right. First of all, the Instant Answers capability is very much going to be layered on top of our knowledge hub. It's just a better way to get to answers using the generative AI capabilities and the underlying large language model technologies. As you and others who are following the space know, ChatGPT is one manifestation of an underlying large language model that is pre-trained on a vast amount of content and billions of parameters. What we are doing is taking the underlying large language models and training them, using some of the core training from ChatGPT but then fine-tuning that with enterprise content, specific to each business. It's important to ensure that their content remains private and secure. So this is a tool that enhances search capabilities, allowing users to find relevant answers faster without having to sift through lengthy documents. The generative aspect is particularly exciting because it can provide concise answers to complex questions. In terms of cost, we are still working that out. There will be base capabilities embedded in the product, but additional advanced features related to enterprise-scale retraining may come as an add-on, which we are currently discussing with some early customers. We’re aware of the increased costs associated with these advanced services.

Richard Baldry, Analyst

Great. I have a quick question. Given the difficult market conditions, I'm curious about your strong cash generation. Are there any plans to start or actively pursue the buyback you announced this fleet? Thanks.

Eric Smit, CFO

Sure. So we have the buyback in place. We put a structured plan through last quarter. There were no purchases through the quarter, but we will evaluate that moving forward as needed.

Operator, Operator

Our next question comes from Jeff Van Rhee from Craig Hallum. Please go ahead.

Jeff Van Rhee, Analyst

Great. Thanks for taking my questions. A couple for you on the sales motion front. I know Rich was asking about the direct side. I want to touch on the channel. What have you seen in terms of the sales motion now, and particularly the momentum there in the channel versus maybe the rest of the business?

Ashu Roy, CEO

Yes, it's a good question. The channel is still generating opportunities; we see that. I think that the larger opportunities that we're chasing are coming through the direct sales channel. The channel is there, and the logos are still the right kind, but the opportunity sizes are mainly add-on opportunities, particularly in the CCAP channel. On the other hand, with the SI channel, we are steadily building up more partnerships. These are the right kinds of large opportunities, but they do have a slower cycle because they involve early-stage conversations and large organizations looking at strategic knowledge projects. However, we are seeing more of these opportunities, which is encouraging.

Jeff Van Rhee, Analyst

Fair enough. And then on GPT, as you look at your prospects and customers, understanding it's happened recently, have you had enough time to get feedback? What are customers and prospects saying, and how is that potentially surprising you?

Ashu Roy, CEO

Everyone is talking about generative AI — not just customers, but partners and analysts too. We are engaging in many conversations about how businesses can leverage it effectively. The fact that we have a solution available puts us in a good position to show others how they can utilize it responsibly and safely. Businesses are particularly focused on compliance, security, and ensuring the correctness of AI-generated answers. They want to know how to implement these technologies within their existing enterprise constraints, and we are ready to assist them with that.

Jeff Van Rhee, Analyst

Okay, awesome. So maybe last from me on the sales side, the bookings environment — you've commented on the macro obviously, and last quarter you said as well was difficult — cycles were lengthening; they've lengthened a bit more here. And you referenced a number of reasons — reprioritization of spend and a number of other things that might be taking place. Just expand on that a little bit about what you saw in the bookings and the ability to close business this quarter. Specifically on things that didn't get done. What are people reprioritizing? What's getting done? What's not getting done? Just expand a little bit more on what's going on there?

Ashu Roy, CEO

What we are seeing is not in every case, but in several cases, we are hearing companies say they need to evaluate their current priorities. Additionally, some companies are taking a wait-and-see approach, opting to monitor the market and possibly open up budgets in the middle of the calendar year. These are the trends we observe in deals that are slowing down.

Jeff Van Rhee, Analyst

And maybe if I could just sneak one last one in on the sales side as well. You commented on the healthy sales and marketing spend that you expect to continue. Can you put a little finer point on that? What are you thinking in terms of, I don't know if it's dollars or percentage, and if you want to quantify it from a rep standpoint, like where did you end ‘22? Where do you think you'll end ‘23?

Ashu Roy, CEO

Even at our current capacity, we have doubled our capacity from where we were previously. That’s what I mean by healthy; we have a solid set of sales team members, and the enablement activities have been executed effectively. We're focused on ensuring they become productive, and driving performance is crucial at this point. Thanks, operator. Thanks, everybody, for listening, and we look forward to providing you an update when we announce our Q3 results. Thank you.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.