Epicor Software Corporation Q3 2008 Earnings Call Transcript

Nov.11.08 | About: Epicor Software (EPIC)

Epicor Software Corporation (NASDAQ:EPIC)

Q3 2008 Earnings Call Transcript

October 29, 2008, 5:00 pm ET

Executives

Damon Wright – Senior Director, IR

Tom Kelly – President and CEO

Russ Clark – SVP, Finance and Principal Accounting Officer

Analysts

Ross MacMillan – Jefferies & Company

Brian Schwartz – Piper Jaffray

Brad Sills – Barclays Capital

Justin Bandy – KeyBancCapital Markets

Richard Baldry – Canaccord Adams

Mark Schappel – The Benchmark Company

Abhey Lamba – UBS Investment Bank

Operator

Good day and welcome to the Epicor Q3 2008 earnings results conference call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Mr. Damon Wright. Please go ahead.

Damon Wright

Thank you, Anthony, and good afternoon to everyone. We appreciate you taking the time to join us on this call. We issued a press release this afternoon detailing our results and you may access that from our Web site at www.epicor.com under the Investor section.

Joining us on today’s call are Tom Kelly, Epicor’s President and CEO; and Russ Clark, Senior Vice President, Finance and our Principal Accounting Officer. Tom will begin the call with a few comments, followed by Russ, who will discuss certain financial results in more detail.

Prior to beginning, I would appreciate your patience as I review our Safe Harbor statement. The discussions on today’s call will include forward-looking statements. These forward-looking statements include statements regarding the company’s expected revenue, earnings and other financial results, as well as expected new product releases including Epicor 9, and other statements that are not historical facts. Actual results may differ materially from those expressed or implied in the forward-looking statements. For a discussion of such risks and uncertainties, which could cause actual results to differ from those contained in our forward-looking statements, please see our Annual Report on Form 10-K for the period ended December 31, 2007 and our Form 10-Q for the period ended June 30, 2008. Today’s comments will also include a discussion of certain non-GAAP financial measures, such as adjusted EBITDA, free cash flow, and non-GAAP revenue and non-GAAP earnings, which exclude amortization of prior intangible assets, stock-based compensation expense, restructuring and other charges. The most directly comparable GAAP financial measures and information reconciling the company’s non-GAAP and GAAP results are included in our earnings release and in the Form 8-K to be filed with the SEC.

With that I would now like to turn the call over to Tom.

Tom Kelly

Thank you, Damon. Yesterday afternoon Epicor’s Board of Directors unanimously rejected the unsolicited tender offer from Elliott Associates and recommended that stockholders not tender their shares into this highly conditional offer. We issued a press release and filed a 14D-9 with the SEC providing a very detailed explanation regarding the Board’s recommendation. Today’s call is to discuss our third quarter financial results, our operational focus and some of the exciting things ahead for this company. Everything we can discuss regarding the Board’s recommendation relative to the Elliott Associates tender offer is in the documents we filed.

Now turning to the third quarter, we all know that the third quarter turned out to be one of the most challenging periods that the markets have seen in years. This was especially true during the last few days of September when massive swings in the financial markets and a great debate around the credit crisis created uncertainty in the mind of some of our customers around the world. As you also know, a lot of business generally gets done in the last few days for any application software company. We did have deals slide across the board at the end of the quarter however because of the flexibility of our business model, we hit the revenue and earnings per share expectations we provided back in July albeit with a different revenue mix. The core fundamentals at Epicor remained strong and these were underscored by our third quarter results. These results reflect our focus on operations, execution, and our ability to match our business model to the economic conditions present.

Revenues hit an all-time record for Epicor and we continue to benefit from our large stable customer base with growing, recurring maintenance revenues helping to generate $18.7 million in free cash flow during the third quarter. This customer base is expected to drive free cash flow of $52 million to $62 million for the year. Customer retention rates remained at near all-time highs at 94% and we brought back to annual maintenance contracts for 142 customers who had previously gone off maintenance. Win-backs, these customers we bring back are in an important addition to our recurring maintenance revenue streams and these contracts represent an incremental $3.1 million in recurring annual maintenance revenues. The reasons behind our industry leading retention rates are clear as we continue to support and meet the needs of our existing customers throughout the world with more than 65 products and product enhancements coming out during the first three quarters of 2008 and we are only weeks away from the general availability of Epicor 9 putting our customers and our company on the cusp of beginning to realize the benefits of more than four years of investment and the latest example of Epicor’s cohesive forward-looking product strategy.

Epicor remains uniquely positioned as the leading provider of business software solutions that help our customers save money and drive productivity throughout their businesses. We differentiate ourselves from the competition by offering a low total cost of ownership and clearly articulating a near-term return on investment. Our distinct market positioning and commitment to providing a clear product road map becomes even more important in light of the current economic challenges. The benefits Epicor offers are clear and led to the addition during the quarter of 155 new names to our growing installed base of more than 20,000 customers.

Now, I just returned from our 16 Annual Customer Conference where despite the times, we had approximately 2000 attendees from around the world. This comes on the heels of record attendance of more than 300 at our Retail Customer Conference in the third week of September. These customers paved their own way to come learn more about the tools Epicor offers to run their business more productively. They were also eager to learn about Epicor’s future product road map and what we are doing to ensure that their future needs will be met as they grow their business or adjust to meet the market challenges and opportunities.

I want to spend some more time covering some of the near and longer term growth drivers that are emerging as part of the product road map we shared with our customers. We believe that it is an exciting time for these drivers, we believe that they are coming on exactly at the right time for Epicor and will give us a great boost as we go into 2009. I will also provide some details on our plans to keep our business model nimble and flexible to help ensure we can continue to respond to rapidly changing market conditions and the opportunities that are presented. First though, I am going to ask Russ Clark our Senior Vice President of Finance and Principal Accounting Officer to briefly highlight some of the financial results from the quarter. Russ?

Russ Clark

Thanks Tom. We provide a fair amount of information in our press release and tables. So, I will provide some additional color around a few areas of our third quarter results and referring to the release for the remainder of the information. GAAP revenue for Q3 of $135.8 million was $1.9 million lower than non-GAAP revenue of $137.7 million due to the impact of NSB purchase accounting deferred revenue haircuts of $1.8 million in maintenance and $140,000 in consulting. You can see the breakout of our Q3 revenue by segment in the statement of operations.

Turning to gross margin details, maintenance gross margins were 75.9% up sequentially by 1.7 percentage points due primarily to our focus on margin improvement for our retail products which have relatively lower gross margins in the rest of our business. Maintenance margins were down year over year as expected due to the addition of a larger mix of retail maintenance revenues in the current year. Our focus on improving services utilization rates continued to pay off with further improvement in our consultant gross margins which came in at 21.9 for the quarter. This is up sequentially by 1.5 percentage points and also up from Q3 ’07 by four percentage points. Hardware margins came in at 13.3% up sequentially from 9.5% in Q2. We continued to see some variability in both our hardware revenues and margins due to the timing of customer orders and product mix. License gross margins were strong at 80.8%, increasing sequentially by 4.5 percentage points and increasing year over year by 3.9 percentage points. The sequential and annual increases are due primarily to a lower mix of third-party products. Total non-GAAP and GAAP gross margins excluding amortization were 50.5% and 49.8% respectively, down year over year due to revenue mix which had a significantly higher percentage of lower margin retail revenues as well as hardware revenues versus the year-ago quarter.

Q3 GAAP net income was $3.8 million or $0.06 per diluted share, non-GAAP net income was $11.3 million or $0.19 per diluted share. Despite a more challenging environment, GAAP and non-GAAP net income continued to improve for the year. Adjusted EBITDA margins also continued to improve for the year coming in at 17.5%, up 2.5 percentage points from Q2 though down slightly by 10 basis points from the same period last year due primarily to the mix of revenues. Looking at our third quarter income taxes, our GAAP tax rate was 25% with the year-to-date benefit of 52%. The variability in our Q3 tax rate resulted from updates to our full-year pre-tax income estimates in order to provide a more normalized tax rate as comparable to other periods we have used the 38% tax rate in our non-GAAP earnings per share calculations.

Moving on, while we do not have control over the economic conditions we face, we do have the ability to adjust our expense structure to appropriately respond to those conditions. During the third quarter, we continued to proactively respond to the developing market conditions by managing operating expenses. As a percentage of total revenue, Q3 operating expenses were down more than 4% from a year ago. Each line item other than R&D was lower as a percentage of revenue than Q3 last year. R&D was up as expected as we approached the general availability of Epicor 9.

Moving on to additional quarterly metrics, our mix of America’s and international software license revenues for the quarter was split approximately 70% Americas and 30% international consistent with our expectations. 2008 third quarter total revenue and costs were almost equally impacted by foreign currency fluctuations. Once again, we had strong collections of approximately $143 million during the quarter and free cash flow continued to improve throughout the year, up sequentially over Q2 by nearly $6 million to $18.7 million. We took advantage of our strong cash generation to pay down our credit facility by a total of $46.8 million during the quarter bringing our outstanding balance down to $109.3 million. This pay down is expected to lower our interest rate to LIBOR plus 2.25%.

As of September 30, 2008 the balance sheet included $95.7 million in cash and equivalents, our total debt balance at the end of the quarter was $339.8 million consisting primarily of the $230 million of 2.38% [ph] convertible bonds and our credit facility balance.

I would now like to turn the call back over to Tom.

Tom Kelly

Thank you, Russ. In this economic environment, Epicor is focused on three primary goals, supporting and growing our customer base by providing high value products that focus on the lowest total cost of ownership for our customers, continuing to target investment to the highest priority opportunities and very specifically and including the successful launch of Epicor 9, and then last continuing to focus on expense management while increasing our focus on driving efficiencies across the business. So as key points, keeping our products coming, lower total cost of ownership, focus on investment Epicor 9 and the roll out of our retail products, and continue to focusing on our expense management and driving efficiencies in the model.

I believe our customer base is our most valuable asset here and customer satisfaction is priority one in Epicor. It is evidenced by our 94% retention rate. We do not sunset products nor do we force customers to move on to new platforms. In fact, we continue to add features and functionality to all our product lines and are constantly bringing to market numerous new product releases all of which are directly targeted to meeting the needs of the customer base. This formula is what results in that high retention rate and that high recurring maintenance and revenue stream that we have as well as providing growth for the future, supporting our customers and ensuring we are addressing their current and future requirements through our product road map is directly linked to our investment and the upcoming release of Epicor 9, which is the latest example of our clearly articulated customer centric product strategy. Now this strategy is a critical element for maintaining our leading customer retention rates as I have mentioned and also of course core to our maintenance revenues. We have invested hundreds of thousands of employee hours and millions of dollars into what we believe will be a top, if not the top ERP solution of choice for every one of the focused vertical markets we are in. We believe Epicor 9 is a game changer for the mid market ERP and will for the first time provide a tier one ERP solution specifically for the mid market. We believe that this product will allow us to take competitive advantage across the board in our markets. We are very excited about it.

I want to remind everyone that this is an important release with significant features and functionality as well. Epicor 9 is the only enterprise application that fuses ERP with Web 2.0 and Enterprise 2.0 capabilities on a proven 100% SOA platform. It connects into Knowledge Worker, it connects in Outlook, it connects in SharePoint, it connects into people that are doing business without directly touching the underlying ERP data. Now they can take the underlying ERP data and through the business intelligence tools that we provide them turn that into real time decision making engine. We think this is a great strategic advantage for our customers and a very big competitive advantage for ourselves into the marketplace. Supporting our customers and ensuring we are addressing their current and future requirements through our product road map is directly linked to our investment in the upcoming releases of Epicor 9.

Now let me talk about a few of our growth drivers as we go forward here that are all welded on the Epicor 9 platform and the retail markets that we are playing in. These growth drivers will include penetrating new markets with the best in class products first and foremost Epicor 9. We believe it is an opportunity to take market share, we think it adds tremendous international opportunity for us and we believe it allows us to move into some emerging markets. We think it allows us to attack new verticals, we also see new term opportunity in addressing unreserved markets as well as driving incremental growth with enhanced distribution and financial product suites. The financial modules incorporate not only multi-language and multi-currency for numerous jurisdictions around the world but also multi-book localization and reporting tools. This is expected to reopen markets for Epicor that we have been unable to effectively address for several years. Epicor 9 will also open up multiple ad news for migrations and upgrades. While we expect that there will be near term interest to migrate or upgrade from specific customer sets, we view this at a longer term opportunity for later 2009 and 2010. The tools will allow us to drive migrations and upgrades from our own installed base of more than 20,000 customers will also be the base tools that we can eventually use to migrate the broader competitive environment. Epicor 9 is just one of the exciting near-term catalysts for Epicor and we have several other growth drivers. In our retail markets we have just begun to leverage Epicor’s existing global reach to penetrate international markets. More and more retailers have or want a global footprint with a reach that spans more than 140 countries, Epicor is well positioned to be the solution provider of choice for those retailers.

Additionally we continue to have near-term cross-selling opportunities into the former CRS and NSB customer bases especially where we can demonstrate a near term ROI. The products that most likely will fall into that category are the enterprise selling and sales audit products that we have in our retail suite of products. The longer term growth drivers in the retail space include expanded retail offers that customers are asking for us. These include the mobile solutions and multi channel retailing as the economy stabilizes we expect to realize the additional tremendous benefits from our February 2008 acquisition of NSB as Epicor is able to more fully leverage its position as a clear market share leader in the specialty retail space. Complementary in adjacent markets to those we currently serve are also expected to drive growth for Epicor. We recently introduced into the US a product funded in cooperation with the Australian Government Epicor’s senior living solution targeting the assisted living aged care and retirement markets. This is a market with growth potentials that are significant are we are already adding customers in the US. We have a very solid customer base in the Australian market with this product already. Given the growth drivers I have just covered, I am confident that Epicor can continue to play a strong offensive game and I believe that times of market turmoil often can create an opportunity to take market share. We are well positioned with an exciting array of fresh new product offerings that are addressing the current and future needs of our improving target markets. We have the products that enable our customers to make buying decisions and we listen to our customers and have responded with solutions they want. Having a strong offense in terms of an excellent slate of products with defined growth opportunities is an important part of our game plan but it does not mean we will ignore our defense. A solid defense is critical to any winning strategy and highly successful teams consistently to demonstrate them on both sides of the field.

It is important that operational focus remains on the forefront of our mindset and in the third quarter we demonstrated that we can effectively adapt our business model to market conditions. We made some adjustments to our model with minor headcount reductions and in aligning our cost structures with our anticipated sales opportunities driving efficiencies across our organization will remain a top priority and we will continue to prudently tune our model to ensure it is properly aligned with the challenges and opportunities we face. We intend to pursue our growth drivers and be opportunistic and exacting incremental growth in today’s challenging environment, in addition we will continue to implement a wide range of cost initiatives throughout our organization to help ensure that we match our business operations and execution to our sales expectations. We will be diligent in managing expenses, driving improvements in our gross margin and operating lines and understanding the demand environment for our customers and markets. We remain highly focused on striking a balance between driving near term improvements to earnings and cash flow and supporting our upcoming product road map to drive an acceleration of long term revenues and earnings growth.

Epicor has a 25-year history of managing through all varieties of economic scenarios and we are well positioned to respond to any market condition or opportunity. Our core fundamentals remain strong, they are a large stable customer base, a strong growing recurring revenue stream, a well developed SOA technology platform based on leading Microsoft technology, and established leadership position in multiple high-growth markets and having proven leading-edge products with near long-term growth drivers in all markets including our Epicor 9 launch right now. We are confident in our business model and our ability to adapt it to match market conditions both good and bad and we will invest for the future while managing conservatively through the near term.

Operator, we are ready to take questions.

Question-and-Answer Session

Operator

(Operator instructions) We will take our first question from Ross MacMillan from Jefferies & Company.

Ross MacMillan – Jefferies & Company

Thank you. Just a couple of quick housekeeping first, just on the strength in hardware and other, can you just elaborate on that and then also related to that can you talk about your expectation for that line item in Q4?

Tom Kelly

First of all, the hardware was stronger in the third quarter as it was really driven in our retail segment and what happened is we saw people deploying their point of sale systems at a fairly rapid pace through the third quarter, in fact far more rapidly than we had anticipated and that became clear as we went through the quarter to get ready for the holiday season, the holiday selling season and that really was what the core of that was. So that really popped things up. It started emerging kind of in the mid to latter part of the third quarter so it became clear that that was going to be an increasingly stronger part of the revenue picture for the third quarter. And as far as the outlook for the fourth quarter, we stayed away from targeting and giving guidance on specific line items in the P&L. Historically our hardware has not been as predictable as other segments, other parts of the business and so I am going to prefer to stay away from giving specific guidance on the fourth quarter hardware number.

Ross MacMillan – Jefferies & Company

On the operating costs, you were down sequentially, you mentioned some limited headcount reductions, but as we move into the Epicor 9 launch, how should we think about operating expenses, are we going to see a kind of tail to launch expenses or is it really going to be one-time in nature. I am just trying to get a handle for as we look into Q4 and beyond.

Tom Kelly

I don’t think you should expect to see a burst in expenses relative to Epicor 9. In these times what we will be doing we will be taking a harder look at how we reallocate expenses within the bucket. We are not going to back off our investment in Epicor 9 [ph] nor back-off our launch of Epicor 9. We think that it is an incredibly exciting product, the reception it received at our perspectives conference just in October here was absolutely outstanding and we fully expect this product to receive great market attention. So, we are going to stay focused on that. Now, that brings us back to do you expect to see a bump in expenses related to that, I think that we can successfully manage our existing expense structure to address that and just shift things around, to refocus, to reallocate as opposed to really grow.

Ross MacMillan – Jefferies & Company

Okay. Final one, just another housekeeping, I think you made mention Russ of the FX impact being equal on revenues and expenses probably, can you just highlight what that was?

Russ Clark

Yes, the impact was in the 1% to 2% range on either but that is roughly the same in offsets so the bottom line impact is really nil.

Ross MacMillan – Jefferies & Company

1% to 2% growth impact on the top line.

Russ Clark

Yes, if you look at it from a year-over-year perspective.

Ross MacMillan – Jefferies & Company

Perfect, thanks very much.

Operator

We will take our next question from Mark Murphy with Piper Jaffray.

Brian Schwartz – Piper Jaffray

Yes, hi, thank you, this is Brian Schwartz actually sitting in for Mark Murphy. Tom, I was wondering, I know you don’t break out the NSP contributions but could you talk qualitatively how the retail area of the business performed versus your internal expectations?

Tom Kelly

The retail is clearly struggling – not struggling, wrong word, retail has taken a bigger part of this economic downturn than ERP. Okay, clearly they have had a – the market out there is showing – from week to week it is showing different signs as to whether or not we see some excitement. It also seems to be that there is a less even kind of distribution of pain within our retail customers. Some of the retail customers with broader and bigger names are still more active and some of the retail customers that you may not have been as familiar with in the specialty space, they are probably demonstrating more caution and so those who don’t rely upon that great market name or brand name presence, so we have got plenty of those that do, we have both big name presence then we have got the retailers that you may not have been familiar with, we tend to see that there is disparity on where their buying conditions are but overall in the macro sense, retail net license revenue is below our expectations and I think it has been. We started off at the beginning of the year where we looked at the integration and at that time it was hard to tell how much was macro and whether or not we have just closed the transaction, we had gone out and communicated our product strategy in the first quarter into the marketplace, there was clearly some confusion that we needed to work through at that time, not confusion in that people did not understand it, confusion in terms of just getting through the process of laying out that road map. That road map is well understood now by the market and the customers and so throughout the second quarter and I believe I know I mentioned this in the last quarter that it was clear that some level of macro conditions were starting to show themselves in the second quarter of this year and the third quarter was a continuation of that. In fact the continuation of that occurred really at the tail end of the customer very much the same way it did in our ERP business and as I indicated we had deals that slit at the end of the third quarter because of the incredible volatility and just the news media, the markets everything that went on in the last couple of days, I think there was great uncertainty and people deferred signing final contracts in the last few days. So retail clearly took a bigger burden on that but we also believe that going forward as I highlighted in my prepared comments that if you look at where we have our greatest expectation for retail in the near term it is in the tools that give immediate ROI and payback, the sales audit and enterprise selling are absolutely tools that we are finding increasing in the pipeline because you can absolutely measure cost reduction or immediate increases in sales stores. There are two products that are designed for that and we are also seeing an increased level of attention in our A pack markets in retail and that is because we have customers that are continuing to look even in these times to expanding into markets they are not playing in right now.

Brian Schwartz – Piper Jaffray

Tom, in building upon you made the comment that business kind of tailed off there at the end of September and that is actually what we are hearing from almost every software company as reported. Can you give us some color or talk a little bit about what you have seen so far here in October, if there has been any change in the demand environment from what you saw towards the last days in December?

Tom Kelly

First of all our guidance for the fourth quarter is trying to reflect this era of greater uncertainty. We have read the same earnings reports that you have and the commentary that come from various people in the industry and to our extent, from my perspective, we are not immune from that. In fact we are playing in the same overall economic environment. So, if I look at October, October is never a “robust”, the first month of any quarter is never a big robust period but it is falling within the category of kind of supports where our thinking is right now. So, that’s all said, right now there is nothing there that is happening that does not lend support, tend to support what our thinking is for the balance of this quarter. We have an election of course next week, we have got all these moving parts out there therefore we did in fact beckon greater uncertainty. Now, what I do like is that I am going to release Epicor 9 in this quarter. So our plan is to have it go out here at the end of November. We do have pipeline building for Epicor 9 in this quarter and there is no question that Epicor 9 is going to be a key part of our Q1 and onward sales strategy. So, that to me is a positive. We expect to take advantage of that and I think that helps in these times to have something new and exciting to be able to talk to for the deals that are in fact going down.

Brian Schwartz – Piper Jaffray

That’s real help Tom. Just one last final question just again hitting on the macro here, looking back historically with the company here at Epicor, during the last recession in 2000 and 2002 the company experienced negative license growth, I know you are not about to give fiscal year ’09 guidance today but do you suspect your license revenue could decline next year even with the Epicor 9 release?

Tom Kelly

I don’t want to talk to that right now, I will feel much better after Q4 but I will tell you this that I will be highly disappointed if that were in fact the outlook on this. Epicor 9 we think is a game changing product. We think it really changes our competitive position, we think we lined up extraordinarily well not only against the traditional mid-market players but we believe that this is a product that will compete against the main tier I products out there in the marketplace. This is a big product, an exciting product. So, everybody wants to have the most robust periods to go into any market but more importantly than that I like the fact that I am writing the front end of a brand new product cycle coming out here and I think the timing on that – new product cycles are always well timed, they are always good, some you can time it better or worse but I like where we are on that right now, I can’t change the macro world but I can in fact control what we are doing here at Epicor.

Brian Schwartz – Piper Jaffray

That’s very helpful. Thank you for taking my questions.

Tom Kelly

Sure.

Operator

We will hear next from Brad Sills with Barclays Capital.

Brad Sills – Barclays Capital

Okay guys, thanks for taking my questions, just curious on what you are seeing on the core business and your manufacturing and distribution with enterprise leads, with the year-over-year and sequential license decline, obviously you mentioned retail being weak can you comment on in the core business macro versus maybe a pre-Epicor 9 release slowdown that you might be seeing, which of those is kind of impacting that business?

Tom Kelly

I actually don’t think it is a pre-Epicor 9 slowdown. I have not seen a lot of evidence to that right now. I really have not because we have been very selective about how it is going out and but I will tell you this is that our pipelines if you look at Q3’s pipelines and you looked at – we got off to a slow start, we had a weak international Q1, we talked about that, we got off to a bit of a slow start in the Americas we were not off to a slow start we were doing just fine and in fact if you were looking at our pipelines throughout Q3 and if you look at what was tracking as we were coming in to the end of Q3, everything was tracking just where it was. It was truly a phenomenon literally that commenced on the last few days of the quarter and we always have a fair amount of business that occurs the last few days of the quarter and the incredible events of those last days just caught – things landed on desks for CEOs and CFOs and they just said we are going to wait till next week, next quarter, whatever. Some of those deals had slid and we have got to determine where they will end up but there is no question that our core business was tracking actually much better, very, very solidly throughout the whole Q3. Things were returning to normal and in the international, things were in fact doing fine in the Americas and it truly was this phenomenon in the last few days where in fact this credit crisis and this economic turmoil just hit a fevered pitch. So, I don’t think that it is anything core to the business in terms of what I call a pre-Epicor 9 slow down or anything other than the fact that we were subjected to this broad economic event in Q3 that everybody else was. Now time sets in I think it does give the chance for people to sort though that which is anxiety and that which is real. There are still deals out there. The analysts in the marketplace the Gartners, the IDCs the Aberdeen’s, they are all projecting growth, some level of growth in 2009 in all their updated reports that have come out in October here growth in the IT sector and growth in software IT. So it is our belief that we hit this hard when we were at the customer conference and in the individual dialogues I have had with customers that continued investment in ERP allows you to gain productivity, allows you to drive costs down, allows you to get efficiencies that may well be more important in these times than in any other time. We think the Epicor 9 product is going to allow us to make that pitch even stronger.

Brad Sills – Barclays Capital

Got it, that’s helpful, thanks. Then just a question, the wind-backs have been a good driver for you in recent quarters, how much more room do you have in your installed base, in other words, is there still a decent list of customers that are still kind of coasting, that are not on maintenance that you are kind of targeting?

Tom Kelly

Yes. We think that that will be a continued focus of us. I never have an expectation that that number is got to be a certain number but it is held pretty constant, it goes up, it is a little up, it is a little down in any given quarter but to this day it has historically stayed within a pretty tight range out there and I expect that to continue. I actually think that Epicor 9 allows us to go back out and add a little more teeth to that discussion when we are trying to get wind-backs. So Epicor 9 helps us on virtually every front.

Brad Sills – Barclays Capital

Okay. Thanks for taking my questions.

Tom Kelly

Okay.

Operator

We will hear next from Steve Koenig from KeyBanc Capital Markets.

Justin Bandy – KeyBanc Capital Markets

Hi guys this is actually Justin Bandy [ph] on for Steve. I was wondering if you could speak briefly about what you are seeing in the competitive landscape if you are seeing your competitors change their sales tactics at all, our checks have revealed some discounting out there by some of your competitors and I was just wondering what you guys have been seeing?

Tom Kelly

Yes in these kinds of times, I think you always see what I call a wider range of behavior in terms of that kind of – it never is helpful when you have got what I call desperate if there is pricing that gets a little bit out of whack but ultimately I have always believed that if our products are strong that we are going to do fine on that. There is probably an increased amount of discounting pressure right now, there is no question that that is happening. That should not come as a surprise to anybody but I don’t believe it is a trend – I don’t believe it is a condition that I am going to point to as being a competitive dislocation. We think Epicor 9 once again having new products and having the front end of releases allows you to buttress some of that as well, to actually fight some of that.

Justin Bandy – KeyBanc Capital Markets

Okay great, that’s helpful. Then just one follow-up question, given where your guidance is trending from the beginning of the year though, revenue guidance has come down, I would assume a large number of your sales reps are under water in terms of their quota for the year and I was just wondering what you guys are going to do to incent them to be productive in the fourth quarter and then if you could comment how that might impact the P&L, how that would impact the cost of sales in the fourth quarter?

Tom Kelly

We think their comp plan is absolute and set them adequately to do well in the fourth quarter. We expect them to get out there to bang hard on this and I don’t think you should expect to see any kind of a wild variation in our fourth quarter expenses that would not normally be there with increased software sales in the fourth quarter. We believe that the comp plan is still adequately in sense, clearly we have sales people that are doing well, we have sales people that have a chance to still do very well and we have those that are still coming up to speed. So we believe the sales focus is still there and the team is very well focused on what they have to get done here.

Justin Bandy – KeyBanc Capital Markets

Okay, great, thank you very much.

Operator

We will hear next from Richard Baldry with Canaccord Adams.

Richard Baldry – Canaccord Adams

In the past when I think it was Epicor 8 it all came out the upgrade cycle was sort of quantified in terms of the value for an existing customer and then kind of multiplied across the applicable base to give a sort of total available upgrade cycle. Is there a similar way to look at that on Epicor 9?

Tom Kelly

I am not sure exactly of the equation there, I did not follow it completely but I will tell you that we expect that Epicor 9 will initially, most importantly drive new business. That will be the most immediate impact of Epicor 9. Traditionally your upgrade activity occurs in the latter part of the year that comes on second. I am not going to pick a date which you will see it but clearly you will see upgrades appearing immediately but the lion’s share of the business, the growth, is in the initially new business and the (inaudible) that is going to drive initially is that Epicor 9 is ideally suited for our international markets and they are awaiting that with great expectation. So, I would expect to see some initial growth driver activity in the international markets. I think you will see the increase of the migrations and upgrade opportunity start to occur throughout the year and grow, grow throughout the year and into 2010.

Richard Baldry – Canaccord Adams

It looks like the service chains are starting to improve under the new leadership and upside, can you talk a little bit about any long-term goals in there that is around the 22% zone, is there a way to think about where that can head to in the sort of near term, long term?

Tom Kelly

I don’t see – there is nothing in our business that creates a barrier for us to reaching industry standard consulting rates for good solid ERP consulting, nothing that prevents that. I indicated that when I took over the – we made the changes after Q1 and I ran that business directly under me before trying to determine where we go and then we put Laury Klaus in there as the permanent leader in that space. We established some changes early on in Q2. Laury has brought additional changes on top of that and so we have seen margin improvements in Q2. We have seen good solid margin improvements in Q3 and I expect to see the long-term trend continue. Now there may well be a quarter where the margins might go down a little bit or up a little bit over a period of time but the trend over time is to keep moving us above 20 solidly and keep trying to grow that. The core part of the business is, it is pretty straightforward if we have got the book of business, we have the right utilization rates, and efficiencies there, we can drive higher margins. We also think that one of the growth areas for Epicor in the services business over the course of the next couple of years is our managed services area. We have a large customer base that is doing a lot of different things with our customers. We have increasing interest in taking advantage of managed services where we will go in and provide a wide range of services ranging from actual, functional support for the product over to certain business process outsourcing functions for our customers. We expect to see that grow, those are typically higher margin product lines and that will also help to boost our overall services business.

Richard Baldry – Canaccord Adams

It looks like you took down about a third of your non-convertible outstanding debt in the quarter, almost $50 million, you do have a $50 million buyback authorized as I recall, can you talk a little bit on the strategy and paying one down versus executing on the buyback which might be more closely tied to shareholder value and then some check figures on headcount exiting the quarter versus exit count exiting Q2 and maybe number of deals over 1 million or over 0.5 million available?

Tom Kelly

Yes we paid down the debt line because it provided us the ability to drop our interest rate and so we have a more favorable interest rate that allows us to keep our debt in the leverage position we want to see it right now and that was kind of the condition in that. In terms of the headcount Russ, do you want to –

Russ Clark

Yes, we had about 3100 employees at the end of Q3.

Tom Kelly

I think that was the answer.

Operator

We will take our next question from Mark Schappel with The Benchmark Company.

Mark Schappel – The Benchmark Company

Hi, good evening. Tom, a question for you, has uncertainty surrounding the Elliott tender offer impacted your business especially with new customer signings?

Tom Kelly

Certainly has helped.

Mark Schappel – The Benchmark Company

Okay.

Tom Kelly

But I think clarity in our response helps clarify that position but anytime you have a unsolicited public offer, those kinds of deals rarely bring value to the enterprise, rarely help you with your employees or your customers.

Mark Schappel – The Benchmark Company

Okay thank you and one final question regarding the pricing for Epicor 9, I assume that existing customers get to upgrade to the product at no charge if they turn on maintenance.

Tom Kelly

They get like for like. So in general terms for what you asked the answer would be yes but in specific terms it is like for like. So, if they were on, if they have the module, if they have that product, they absolutely do in fact get to upgrade and in some cases that is a very positive upgrade giving an example the financial module is a greatly expanded financial module today that our customers will get broad benefit for having been on the maintenance. So, when they are going from the existing financials product to the new financials, they are getting kind of a tier one financials product when they move up.

Mark Schappel – The Benchmark Company

Thank you.

Operator

We do have time for one more question, we will hear from Abhey Lamba from UBS Investment Bank.

Abhey Lamba – UBS Investment Bank

Yes thank you. Tom looking at the history of your product releases, typically how much time does it take for your customers to start purchasing a new version especially of the type of upgrade that Epicor 9 is and what type of revenue expectation can Epicor 9 bring in over what time period?

Tom Kelly

So, let me understand, how long does it take for them to implement it?

Abhey Lamba – UBS Investment Bank

No to start purchasing it, because at times customers wait for some testing period or some service packs or point releases?

Tom Kelly

Okay based on that, I think the history if I understand it at Epicor and as I see it in the lot of the other ERP customers that your existing customers that we should expect – you will see a gradual adoption, some in Q1, some in Q2 but it is definitely increasing where we would expect to see in the latter part of 2009 significant migration activity on Epicor 9 and clearly into 2010. They will be looking obviously what they look to is the new customer adoption rate that is always a key driver for existing customers. Now but the new customers of course will look to some level of – you know, customers that have gone live on it at the time that we sell, so we do have some of our data, we have a much expanded data program on Epicor 9 that we did over Epicor 8. We have over 80 data [ph] customers and a number of those will in fact go live here in the fourth quarter. So that will be a strong support for the new customer sales. So I think I can’t give you a qualitative kind of an equation to allow you to calculate out how many upgrades but clearly you will see an increase throughout the year and it will be directly tied towards kind of the successes we go out and hit the marketplace with new customers.

Abhey Lamba – UBS Investment Bank

Got you and lastly, have you closed any of the deals that slipped through Q3 in October are they still in the pipeline?

Tom Kelly

We closed some but I don’t have an exhaustive list in front of me but we have closed some and my experience though is when something slides from – kind of a casual comment, I rarely have seen when a sales guy, a sales executive walks in and says it is going to slide to the first two days in the next quarter, that is a pretty rare event when something slides from the last day to the quarter to the first or second day of the next. It almost invariably slides a month, I mean invariably. That is true for good times or any times. So, I know that we have closed some but I don’t have a hard number for you right now.

Abhey Lamba – UBS Investment Bank

Okay thanks. Lastly, I know you are not giving ’09 guidance but qualitatively should we expect you to grow in line with the market next year of (inaudible) in the market and how about margin leverage, do you expect to get some margin leverage next year?

Tom Kelly

First of all I am not going to give you ’09 guidance but I will tell you qualitatively my team here knows that I expect us to grow at or above the market, they know that and I don’t ever expect anything less than that in terms of the business. My team also knows that I believe that we have a great opportunity for margin improvement over time here at Epicor. So those will be drivers in how I construct our models and how we evaluate the opportunities for next year and I hope to reflect it as we have more clarity into what ’09 looks like.

Abhey Lamba – UBS Investment Bank

Okay, thank you.

Operator

Gentlemen, there are no further questions at this time.

Tom Kelly

Okay, thank you operator. In closing I want to turn my attention to our two most important constituencies, as I have done each time, to our customers and to our employees. It was great to personally meet hundreds of our customers at our conferences over the past few weeks and I want to reiterate our thanks for their commitment to Epicor and their confidence in our solutions running their businesses throughout the world. Our employees around the world continue to work diligently to ensure we are able to deliver our current and future commitments. We have an incredible team that does an excellent job for Epicor and our customers each and every day. Their dedication continues to be reflecting in our growing customer satisfaction rates and industry leading customer retention. Thank you to our employees, thank you to our customers, and thank you all for joining this call.

Operator

That does conclude today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!