Lawson Software, Inc F2Q09 (Qtr End 11/30/08) Earnings Call Transcript

| About: Lawson Software, (LWSN)

Lawson Software, Inc (NASDAQ:LWSN)

F2Q09 Earnings Call

January 8, 2008 4:30 pm ET

Executives

Barbara Doyle -Vice President of Investor Relations

Harry Debes - President, Chief Executive Officer, Director

Robert A. Schriesheim - Chief Financial Officer, Executive Vice President

Stefan B. Schulz - Senior Vice President of Finance

Analysts

Mark Murphy - Piper Jaffray

Tom Ernst - Deutsche Bank Securities

Peter Goldmacher - Cowen & Co.

Steve Koenig - KeyBanc Capital Markets

Richard Williams - Cross Research

Brad [Stills] - Barclays Capital

David Bayer - Cantor Fitzgerald

Operator

Good afternoon and thank you for standing by. (Operator Instructions) Today’s call is being recorded. If you have any objections you may disconnect at this time. Ma’m you may begin.

Barbara Doyle

Thank you Valerie and good afternoon everyone on the call. Welcome to Lawson Software’s Fiscal 2009 Second Quarter Conference Call, which covers the quarter ended November 30, 2008.

With me on today’s call are Harry Debes, Lawson’s President and Chief Executive Officer; Rob Schriesheim, Executive Vice President and Chief Financial Officer; and Stefan Schulz, Senior Vice President of Finance. After completing our prepared remarks we will take your questions as the operator described.

Now please allow me to review our Safe Harbor statement.

We would like to remind you that the call will include forward-looking statements which are subject to risks and uncertainties. These forward-looking statements contain statements of intent, beliefs, or current expectations of Lawson Software and its management. Such forward-looking statements are not guarantees of future results and involve risks and uncertainties that may cause actual results to differ materially from the potential results discussed.

Our SEC filings contain further information about risk factors that could cause actual results to differ from managements expectations. We do not obligate ourselves to update forward-looking statements for circumstances or events that occur in the future.

I would also remind you that in addition to reporting financial results in accordance with Generally Accepted Accounting Principles, Lawson Software reports non-GAAP financial results. Discussion of our use of non-GAAP results as well as a reconciliation of our non-GAAP results to GAAP is included our press release.

With that please let me turn the call over to Harry Debes.

Harry Debes

Thank you, Barbara and good afternoon to everyone.

During today’s call I will be giving some comments on the quarter and Rob will cover our Q2 financial performance and will discuss our financial guidance for Q3, then I will wrap up the call with some closing comments and we will take your questions. With that let us begin.

Even with the negative impact of foreign currency exchange during the quarter our Q2 revenues of $206.5 million met our guidance. Our non-GAAP earnings per share of $0.10 was at the top end of our guidance range. We delivered non-GAAP operating margin of 12% and that is the highest operating margin we have achieved in any quarter since the merger with Intentia: operating margin and earnings per share both increased year-over-year.

We signed more than 250 software deals in the quarter. Two are greater than $1 million and nine were greater than $500,000.00 and that was slightly up from last year.

Our healthcare vertical continues to excel even during the challenging economic climate. When it comes to the manufacturing and distribution sector we are finding that these industries are being most severely impacted by the current macro economic environments. Weaker demand from their customers means that these organizations are more cautious about undertaking major new capital projects. As a result, M3 software sales were slower than last year in Europe as well as in the Americas.

When it came to new business close rates were impacted by numerous customer deferrals as many prospects hit the pause button on new projects. We did sign 16 new deals and there was at least $8 million of software business where Lawson was selected as the vendor of choice, but where prospective customers simply decided to wait for three to six months to see if the economy improves before they can commit funding to these projects.

The silver lining to the quarters license signing was that business with existing customers held up very well. Last year we introduced a robust portfolio of new products and now our customers are finding immediate benefit and value in these solutions.

Overall, existing customers accounted for 80% of our total contracts in the quarter and the average selling price of deals with customers rose 15% year-over-year.

Consulting revenues were $86 million, up from the previous quarter, but down from the same quarter last year. This is not a surprise as we have 154 fewer consultants than we had last year and that translates to approximately $10 million per quarter in revenue.

We have told you for some time that our plan is to gradually reduce the percentage of revenue that comes from consulting. At the time of the merger with Intentia consulting revenues accounted for 47% of total revenue. In Q2 fiscal ’09 services made up 42% of total revenue. We expect it to be 40% in Q3 and over the longer term, as we continue to build up our partner network, we should expect that direct services revenue from Lawson will be in the range of 35% of our total revenue.

At the same time we remain focused on increasing our services margin. Margins in Q2 improved over Q1, but did not improve compared to the same quarter last year. In November we appointed Eric Verniaut to become our new Executive Vice President of Global Services. We also appointed a new head of services for AMEA and he started on January 5. Their mission is to improve our services margin.

When it comes to our maintenance business we remain very pleased with the progress both in renewals, revenue growth and pricing discipline. This is partly due to the focus we have on delivering more value to our customers and we are doing so by improving our service levels and delivering innovative enhancements to their existing Lawson Solutions.

At the highlight of the quarter is that despite a weak economic climate, we delivered one of the most profitable quarters in our history. This just proves that the adjustments in investments that we have been making are starting to yield results.

Now let me turn the call over to Rob Schriesheim for further discussion on our financial performance.

Robert Schriesheim

Thanks Harry and good afternoon to everyone on the call.

Non-GAAP earnings per share of $0.10 increased a penny year-over-year. Revenues declined by 6% year-over-year reflecting the customer deferrals Harry discussed. A decline in consulting services revenue and a negative impact due to currency fluctuations in the quarter. Adjusting for the effects of currency revenues declined about 1%.

During the quarter foreign currencies significantly weakened versus the US dollar. The euro weakened by 16%, the Swedish krona weakened by 26% and the British pound weakened by 18%. With 40% of our Q2 revenues generated in AMEA, 4% in Asia Pac regions and 56% in the Americas currency fluctuations had the effect of reducing revenues by 5% in total. However, there was no material impact on net income or EPS as expenses were equally reduced.

By line item of revenue license fees were down 9% as reported or 4% in constant currency. Consulting revenues declined 15% or 10% of constant currency. Maintenance revenues increased 6% on a reported basis and 10% at constant currency. This is organic growth and maintenance and not artificially increased by any acquisitions. We have high customer renewal rates driven by our R&D investment and new products and a new service offering such as managed care from which our customers derive value and benefit.

The 10% decline in services revenue as a constant currency reflects fewer billable consultants, primarily in Europe. S3 consulting revenues remain largely unplanned. We anticipated lower services revenues as we balanced capacity with demand forecast and intentionally reduced services as a percent of our business mix. We called this out in our Q2 guidance.

Consulting margin was lower than planned, however. Consulting margins of 15%, while improved from Q1, declined from 17% a year ago. Our Manila team billed 57 service hours in Q2, up from 30,000 last year, so we are clearly making progress on our off shoring efforts. We continue to work on improving our utilization however; as current rates are lagging our expectations and we don’t find them acceptable.

Despite a drop in consulting margin, total gross margin increased year-over-year due primarily to a shift in the mix of revenues away from services and towards maintenance. On a year-to-date basis maintenance comprises 45% of our revenues this year compared to 40% last year.

Non-GAAP operating margin also increased year-over-year by 200 basis points to 12% and improved product mix, higher base of recurring revenues, stable business in our healthcare vertical, product add-on sales to existing customers, efficiencies in our operations and sensible discretionary expense management helped offset lower software and services revenue.

Our non-GAAP cost and expenses declined year-over-year by 3% at constant currency, driven by transformations in our global operations that began in early 2007. These actions are paying dividends now, accounting for approximately 100 basis points of margin improvement in Q2.

In November we announced cost reductions in light of the global economic environment. Many of the reductions were extensions of the transformational actions already underway, although the anticipated severity of the recession accelerated the pace of our initial plans. These actions are expected to reduce expenses by $40 to $50 million annually, beginning with about $5 billion of savings in Q3, growing to $10 to $12 million a quarter by Q1 of fiscal 2010.

In combination with the changes we implemented in 2007 we have achieved a total of about $80 million in sustainable cost savings since the merger on an annual basis, driven by process reengineering and simplification that is more than arbitrary cost cutting.

For example, we built a more flexible global workforce; we have created shared services centers in Switzerland and Manila; we have simplified many operations across our company creating consistent, repeatable, profits globally. We added resources in our targeted vertical business units, raising our companies profile in these industries with customers, partners, and other influencers, and we have invested in our infrastructure implementing Lawson 9 globally so we now have a uniform global general ledger system adding business efficiencies and insight.

In aggregate the business has successfully achieved a major transformation since the merger that is driving improved operating margins. The key remaining area for Lawson where sustained improvement is required is services. We have made progress, including 12% of our total billable hours now being delivered from Manila; however more consistent services execution is needed to achieve acceptable margin targets. Improving the services margins does get more complicated in a weakening economy, but we are focused on this goal. We have successfully addressed our other business challenges and we do likewise with services.

Non-GAAP net income increased 6% year-over-year. EPS of $0.10 benefited by 400 basis points of improvement in our effective tax rate, and 10% fewer diluted shares outstanding year-over-year. Fully diluted shares currently stand at $164 million, down from $182 million a year ago. The improved tax rate and lower shares offset a 66% decline in interest income.

Cash flow from operations was -$43 million which was consistent with our plans. Q2 is the low point in our fiscal year for cash given the timing of our maintenance contract renewal cycle that begins in the second half of each fiscal year.

Fiscal 2008 gives us a good view of our typical cycle. Cash flow from operations was -$50 million in Q2 last year before turning to a positive $24 million in Q3 ’08 and a positive $128 million in Q4 ’08. We will see a similar pattern this year with negative cash flow in the first half and positive cash flow in the second half of the year.

Our cash position remains very healthy with $313 million of total cash and equivalents and $67 million of cash net of debt on the balance sheet. Our cash position will continue to strengthen in the second half of the year.

Total deferred revenue of $198 million declined from $275 million in Q1. Again, this is a typical pattern also influenced by the maintenance schedule as maintenance revenues recognized ratably over the 12 months following the renewal date.

Within the deferred revenue balance deferred license revenues of $50 million declined $7.7 million from Q1. We completed a major project milestone at Fining, a large M3 customer, and recognized nearly $3 million of license revenue associated with that major phase of the project. This was in our plan and the milestone was completed on schedule. We do not have any project milestones as large as the Fining delivery for the remainder of the year, so the roll-in will be adding more even rates of between $8 million and $10 million per quarter.

Now let me move on to our guidance.

For Q3 we anticipate total revenues in the range of $183 to $187 million at current exchange rates. Given our non-GAAP effective tax rate of 35%, we expect non-GAAP EPS to be in the range of $0.07 to $0.09 per share and GAAP EPS to be in the range of $0.03 to $0.06.

I would also like to provide some perspective on our guidance to give you the benefit of our thinking.

There are three primary factors to consider when comparing our Q3 guidance to the prior year: currency rate fluctuations, resizing and transitioning our services business, and lower costs driven by restructuring. For contacts our total revenues were $213 million in the comparable period last year and non-GAAP EPS was $0.08.

First, we estimate that currency will continue to negatively impact revenues in Q3 given current trends. We anticipate Q3 revenues will be down in the range of 12% to 14% year-over-year with currency causing about 6% of the decline. Because of our large employee base outside the US, these currency fluctuations will also reduce expenses, resulting in minimal impact on EPS.

Besides currency, the other major differences in revenue year-over-year will be in services. As Harry discussed, we forecast a lower mix of consulting services revenues this year. We estimate services will be approximately 40% of total revenues in Q3, down from 45% last year.

Maintenance revenues should continue to hold up well, although they may decline slightly sequentially due to currency impacts, and we continue to forecast conservative software contract close rates through the remainder of our fiscal year given the global economy. As an indication, we had 196 AE’s on average during fiscal ’08 and we now have 178 AE’s.

We anticipate that Q3 services gross margin will decline year-over-year which is clearly unacceptable to us. We have initiatives underway to address services performance. While we expect services margin to directionally improve in Q4, the full benefit will be seen in our quarter ended November 2009 given the seasonally weak August quarter.

Regarding our cost structure expenses will be lower year-over-year due to currency and the restructuring actions we announced in November, including the reduction of approximately 200 employees in December and January. These actions, in addition to the benefits we are accruing from the transformations in our global operations that began in early 2007, should help us to maintain or even slightly improve our non-GAAP operating margin year-over-year.

To summarize, we are operating our business to meet the challenges inherent in a difficult business environment. We have struck a balance between managing our costs while maintaining healthy levels of investing in our products, people, and infrastructure. While we are cautious in this economy, we continue to focus on the goal of increasing our FY09 operating margin over fiscal ’08.

With that let me turn the call back over to Harry.

Harry Debes

Thanks Rob.

By now it is pretty clear to all of us that we are in the midst of a recession. The entire industry is

experiencing a slow down in demand. But, ERP projects cannot be deferred indefinitely. Eventually we will return to a more normal level of software buying behavior and when that happens, we at Lawson are well positioned to deliver on our promise of mid to high teen operating margins and here is why.

First, companies who have well-tuned systems are better equipped to weather economic storms. Lawson Solutions have a long track record of helping our customers manage their businesses more effectively. Quite simply, we help our customers cut their costs. ERP may not be sexy, but it’s mission critical and it’s proven.

Second, while the current economy requires us to be cautious in our forecast, it does not in any way affect the confidence we have in our people or our business, about the progress we have made, or the path we are on. We have a large, diverse, global customer base. We do business in multiple industries, including some with less cyclical nature than others; our business model is strong and viable, and we have a multi-year history of delivering on our financial commitments.

Third, we have now completed most of the projects that were on our to-do list to integrate the Lawson and Intentia businesses. Sure we still have a few challenges that remain, but compared to where we were two years ago, they are relatively minor. The changes we have made in the last two years to streamline and transform our business provide us with a very solid base to weather this economic cycle. Our focus on continuing to deliver strong operating margins is unwavering, and our Q2 results demonstrate our resolve in action.

That concludes our prepared comments. Operators please open up the lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Murphy from Piper Jaffray.

Mark Murphy - Piper Jaffray

Thank you. Congrats on the margin progress during the quarter.

Harry, from talking to a number of your partners it sounds like they are actually seeing deal pipelines that are up year-over-year and so it probably becomes a question of close rates. Does that correlate to what you’re seeing in the pipeline?

And, with respect to the Q2 guidance can you talk to us about what your license close rate assumption might be versus historical norms?

Harry Debes

Sure Mark, first of all you are right. We do feel good that we are building a solid pipeline, that our pipeline is in fact strong. But I think, as I mentioned in my prepared remarks, it is not that we are not winning deals, it is just that the deals even when won aren’t being funded by boards of companies because they have some sense of nervousness about their predicaments and I think they are in cash preservation mode right now. As I also said, I don’t expect that to go on forever and at some point I think the dam is going to break here and we are going to see back to normal kind of patterns.

In terms of our close rates I can’t give you the exact percentage, because I don’t think we quote on that, but it is less than what it has been. For example, in fiscal 2008 when we weren’t experiencing that, you know this kind of anxiety in the market. Does that answer your question?

Mark Murphy - Piper Jaffray

Yes thank you very much.

As a follow up for Rob, I think you talked about maintenance pricing having been very healthy in the quarter. Have you seen any change in maintenance renewal rates or are there any customers, even if it they are small in number, that are attempting to say “let’s save a few bucks and see if we can go a few months or even a year without the maintenance”?

Then as a sub question, how do you think the maintenance revenue would trend this year if 2009 does end up being a very challenging economic climate?

Robert Schriesheim

We haven’t experienced any change in our maintenance business. That is the simplest answer to your question.

Harry Debes

And you know Mark, it is actually a little bit surprising because we expected that we might, because we have heard all this noise about what’s going on with SAP. But don’t forget, our tactics and our response to the customers situation have been quite different from that of SAP’s. Instead of raising their rates to an usual level, we figured out how to deliver more value for approximately the same rate that we have been charging historically, aside from normal increases. So, we have had very little push back from our customers. Nothing more than what we have had in the past.

I think you should remember that maintenance is also a bit of a lagging indicator of current economic times, so take that into consideration.

Mark Murphy - Piper Jaffray

Okay and then just one last one. Thinking about Q2 visa vie the deals that may have slipped out of Q1. Is there a net benefit on your license line in Q2 by closing deals that slipped out of Q1 or is there an equal or even greater amount that slipped out at the end of Q2?

Harry Debes

I would say there as a greater amount that slipped out of Q2. I think that in Q1 we really didn’t feel the impact of the anxiety levels until very late in the quarter, in other words the last week of the quarter. I forget that was August, right? It was the last week of August. But, I think the time we were in our Q2, September, October, November, we were well and truly in the midst of the maelstrom. I mean the news media was full of bad news and I think that people got caught up in that.

We are right now in a confidence crisis I think.

Operator

Your next question comes from Tom Ernst from Deutsche Bank Securities.

Tom Ernst - Deutsche Bank Securities

My questions are on the services business. You have been able to significantly bring down the size of that business and this has come although the licensing revenue has only been down slightly. I am curious how strong the uptake of third party service support has been, particularly in Europe where I think your service revenues declined the most significantly on the M3 line.

Are you getting a large number of partners to pick up that slack or are you finding you are able to just eliminate the services needs altogether in the customer?

Harry Debes

No, in fact there are a large number of new partnership arrangements that we have, at an unprecedented level. If you remember back in the old Intentia days, they really didn’t have a partner strategy at all. Pretty much 99% of all services work in Europe was in fact delivered by Intentia and we have changed that model.

However, we do have criteria for what it takes to be a Lawson partner. We don’t just sign up anybody who walks off the street. We need and expect our partners to have a certain level of competence and they need to be certified to certain minimal standards, because ultimately what they do in our customers’ sights is going to impact our reputation.

Therefore, we are signing up new partners, but at the same time we also expect them to live up to certain expectations. So, I would be fair to say we have a backlog of organizations who want to be partners, but haven’t quite become authorized by us at this time.

Tom Ernst - Deutsche Bank Securities

Okay I see, but the actual uptake of third-party partners doing new business that weren’t last year at this time, for example, is that equal to the magnitude of overall service decline in your business? In other words, your guidance is for somewhere around $74 million in services work, plus or minus a couple, in Q3.

Harry Debes

I am going to restrict my comments mostly to Europe because this is where most of the phenomenon, in fact, has taken place. It would be fair to say that over the last two years that yes the partners have picked up what has been declined, the services revenue has declined at Lawson, which is fine.

Tom Ernst - Deutsche Bank Securities

Okay good. One final question, which products are you seeing the best up selling into your customer base? I think you mentioned 80% of contracts in the quarter were up sold products. Is that a consistent amount in the revenue level, and then which products are the strongest?

Harry Debes

Well our business intelligence is strong. Our human capital management solution is strong. Our Talent Management Solution, that is going just pretty much as we expected. Our Business Analytics, as I said, is strong. Also the LSF version for M3 customers, now the similar technology upgrade; that has gone exceptionally well. Then finally the 7.1 release, which we released about 18 months ago, the new version of the M3 product, we have had close to 300 customers accept that solution in the last 18 months. So we are thrilled with that uptake.

Operator

Your next question comes from Peter Goldmacher from Cowen & Co.

Peter Goldmacher - Cowen & Co.

Rob, you had mentioned that you had taken AE’s down from 196 in ’08 to 178 in ’09. I assume some of that was just calling the herd and is it safe to assume that most of that was on the M3 side?

Robert Schriesheim

Yes, well it was through out the organization. The answer is yes, a substantial portion was, as you would put it, calling the herd, but it was also probably more weighted towards the M3 side than the S3 side.

Peter Goldmacher - Cowen & Co.

Okay. Can you talk a little bit more about the services business? What sort of programs are you putting in place internally to make sure that as you exit the services business internally and you’re partnering up externally that you have got account coverage in the local geographies to ensure that you are getting internal participation with your third-party delivery partners?

Harry Debes

Well we have launched a formal partner program. We have a website. We have a certification program associated with that, as I said before. We have partner events and we have partner training. We deliver the partners free copies of our software. We introduce them to our clients. They come to various user group events and meetings that we have. In certain parts of the world we have a great staffing and great relationships and in other parts of the world we still have some work to do.

Peter Goldmacher - Cowen & Co.

So when you look at this as a process are you halfway through and at some point can you dial back spending on the outreach and expect more profitability flow through and if so where are we in that?

Harry Debes

First of all I think what you are hinting at is that the partner program initiative is costing us a lot of money. It is not. It is a relatively small program. We have some resources allocated to it, but we don’t see that those resources that are allocated to this program will decline, because once you create a partner community you need to feed that partner community with information and keep them current. So, it is not a large program.

In terms of where we are, I would say we are about 1/3 of the way through, so we still have a lot of work left to go before we feel comfortable that the partner eco system is fully up and running or staffed to the level that we would like to see it.

Peter Goldmacher - Cowen & Co.

Okay and then just one last question on the off shoring and I apologize if you already spoke about this, but where are you on the cost benefit of taking out the big chunks of savings in the off shoring in Manila?

Harry Debes

Are you saying taking out savings in Manila?

Peter Goldmacher - Cowen & Co.

I’m sorry, taking out costs or savings.

Harry Debes

So Manila, as Rob said we are very pleased with the progress. For example, 50,000 hours we’re delivered, up from 30,000 in the quarter, 12% of our total billable revenue. But, there is still more capacity there, Peter, and I think that is the part hat we are still working on. The capacity exists. We did go through a hiring and training phase. We are nearing the end of that phase now. We are not hiring actively anymore. Now our focus is making those people that we hired and trained productive.

There is still some work, frankly, for us to do, that we are not completely comfortable that the up take is as broad, as well accepted, as we would like it to be.

Robert Schriesheim

Peter, I think the way I think about it, the way we think about it, is that look you can clearly see that the overall margins of the business have dramatically improved. I mean I think the first quarter post merger was like 3%. Last year at this time it was 10%, so it is 12%. Clearly a lot of that has come as a result of our utilization of Manila. But, we always said, we have always been open in saying that we wanted to get the utilization, the number of hours delivered to Manila to be about 20% to 25%. We are currently at 12% and so we are clearly not where we need to be in terms of our utilization of the Manila resources.

Now again, I think that we’ve solved every other issue and we will address this issue also. I mean we have it identified. It is just taking longer than we would have liked.

Peter Goldmacher - Cowen & Co.

One last question competitively. Are you seeing a change from work on SAP in your market? Are they re-trenching or are they exiting your market to focus on their core strength? How is that dynamic changing?

Harry Debes

No real change, I mean other than just a normal fud about oh Lawson’s is going to go out of business so we are going to buy them in the next five minutes – that normal BS that they throw out when things get tight. Other than that…

Peter Goldmacher - Cowen & Co.

They are buying you? What are they going to pay for you?

Harry Debes

You know I am just saying that this is not what the corporate message is, this is what desperate AE’s say to prospects when they run out of things to say.

Peter Goldmacher - Cowen & Co.

Okay, so there is no deal, you are not announcing anything?

Harry Debes

Peter, if there is anything that happens like that we will call you first, okay!

Operator

Your next question comes from Steve Koenig from KeyBanc Capital Markets.

Steve Koenig - KeyBanc Capital Markets

I just have a quick housekeeping question or two and then my primary question. Did you all happen to say how much contracting activity there was in the quarter?

Robert Schriesheim

No, we didn’t. We didn’t give our contracting. We don’t give that information.

Harry Debes

We had 256 deals.

Steve Koenig - KeyBanc Capital Markets

Okay, it seems we have had that in prior quarters, so that is something we should not expect from here on out?

Robert Schriesheim

We gave it in the first four quarters after the merger with Intentia, the cost of the complication of the revenue recognition, establishment of ESOE and everything else so that just giving people the recognized license revenue wasn’t an adequate story, so we went further and gave contracting.

We haven’t given contracting in a couple of quarters. Occasionally we do. Most people can, I think, triangulate around it by looking at the total number of deals and the average price of a deal, which is in our press release.

Steve Koenig - KeyBanc Capital Markets

From your comments about the roll off of deferred that in this quarter, due to the Fining deal it was maybe $3 million above what the normal $8 to $10 million level was.

Robert Schriesheim

Yes, yes.

Steve Koenig - KeyBanc Capital Markets

Then that leads me to what I really wanted to ask you about was in terms of the growth rate that you expect to see for contracting going forward, when I look at the guidance for Q3 it looks to me as if your expectations for contracting or at least for license revenue is a bit weaker than certainly what I expected and what I think is implied perhaps in some of the census expectations.

Am I reading that wrong or is that something to do, is it solely due to the roll-off in deferred in that change with Fining or are you building insufficient, making sure that you don’t disappoint. I mean, how do I read that when it looks like the number looks a little soft for me, even taking into account the consulting revenue, how you’re managing consulting revenue down.

Robert Schriesheim

Well I feel like saying yes to all of the above, but the answer is listen, every quarter we are questioned on the guidance we give. Is it conservative? We try to give realistic guidance. I think obviously in this environment there are some companies that have decided not to give guidance at all, because even though we feel pretty strongly that we have a rigorous process in place, we do all the normal things that every software company does and probably then some. The normal historical data and trends etc…don’t necessarily apply in this environment because we can’t control what is going on in the minds of a potential purchaser in a recession. Particularly in a recession that is as severe as this one.

So, when we gave our guidance, and I tried to give an unusual amount of color behind the thinking around our guidance; the fact is the definition of a recession, particularly one that is this severe, is you are in a contracting economy. I tried to also point out the data that we have pretty significantly reduced the number of people in our sales force and Harry also talked about the level of deferrals that we experienced where we were selected as vendor of choice, but we were deferred until the companies can be more comfortable in making a commitment.

I think what we gave was guidance that we’re comfortable with. It is always difficult when someone says well gee is that conservative, or is there anything odd going in your business? There is nothing odd going on in our business expect for the fact that we are operating in a recession that most people characterize as being the worst recession since the great depression.

The other thing I would offer is that look we just had a pretty good quarter, I think, a reasonably good quarter. When you look at our margins and you look at our overall performance, and particularly on a year-over-year basis, in a pretty bad recessionary environment. We are trying to do our best to manage the business in that type of environment.

Operator

Your next question comes from Richard Williams from Cross Research.

Richard Williams - Cross Research

I wonder, Harry, if you could give me some geographic color and I have a follow up question after that.

Harry Debes

About 55% of our business came from the Americas. I think historically about 4% or 5% comes from Asia and the balance comes from Europe.

Richard Williams - Cross Research

What in terms of strength, weakness, products?

Barbara Doyle

The biggest decline was in AMEA and a lot of that decline, Richard, was driven by currency.

Harry Debes

Our biggest strength actually was Asia. Unfortunately Asia is relatively small, but actually Asia, their performance would lead you to think that there wasn’t anything going on over there in terms of a recession. They actually exceeded their targets for the quarter, so we are very pleased about what they did. But, it is a small portion of our business today.

Barbara Doyle

From a performance perspective, the revenues from the Americas were actually up 1%. Total revenues from AMEA were down 15% as reported, but when you adjust that for currency they were only down about 5%. Then as Harry said, Asia Pacific was up about 14%.

Richard Williams - Cross Research

Okay and of the $8 million in deals that got pushed out, are there any commonalities, any industries in particular, products?

Robert Schriesheim

You know manufacturing, mostly manufacturing and distribution related industries.

Richard Williams - Cross Research

Okay and were they of a similar size as customers go?

Robert Schriesheim

Actually they are all over the map. A couple were quite large, in the multiple millions of dollars in terms of license, and a bunch of medium size deals as well. I am not including everything. I am not including small projects, but I know for a fact of about six, seven deals that were meaningful.

Richard Williams - Cross Research

Okay and from your perspective do you get the sense that the credit crisis is still getting worse or is it leveling out or how do you see it?

Harry Debes

I don’t know what’s going on in the credit crisis. I know probably less than you know, in terms of I read the papers and I watch CNBC like everybody else. I don’t know what is going on in the credit crisis. All I know is that from our customers’ perspective some industries are severely impacted, others like healthcare, apparently, aren’t as severely impacted, because right now what we have seen to date is that their desire to invest in ERP systems seems to remain pretty darn strong right now.

Now I am hoping that that will continue, but it is difficult to predict.

Robert Schriesheim

What we do know is that in this environment, every company that we are aware of is going through their own re-plan exercise, and if they are on a calendar year fiscal year they have now just put in place their new budget and from what we can tell, for certainly the first half of calendar year ’09 people will be very, very cautious on spending. That is what we know.

Harry Debes

That is absolutely correct and as I have been traveling around for the last six months meeting with customers, I did a lot of traveling in the last six months, it is pretty much, their story sounds a lot like our story. For the first half of calendar 2008 everything was going great. Then since around July, August, everything is on hold and Rob is actually right. They all had re-plans. Some of them had major restructurings. Under those circumstances they are reluctant to take on new spending initiatives, so that is kind of what we are seeing right now.

Operator

Your next question comes from Brad Stills from Barclays Capital.

Brad Stills - Barclays Capital

You mentioned that healthcare was strong for S3, can you comment on some of the other professional services verticals and what you might have seen there?

Harry Debes

In terms of verticals for S3 our focus is on healthcare first of all and public sectors secondly.

Public sector had a pretty good Q1, Q2 not quite as strong. We think that there is business there, there is opportunity there, but it pales compared to what we have been seeing in healthcare. We don’t really focus on a lot of other service industries besides those two.

Remember, our message and our whole vision has been to narrow our focus into a few select industries and do an outstanding job there. It is not like we are trying to hit 17 different industries at the same time.

Brad Stills - Barclays Capital

I understand thanks. Then you showed good improvement on the deal side. Do you have any color on what is driving that? I mean it sounds like you’re able to get more of the cross sell in there. Is it simply just a result of that, selling more modules into accounts?

Harry Debes

I will tell you it is a conscious decision we made some years ago when we first launched LSF. We realized during that exercise that if we could package meaningful pieces of software that were easy to install, easy to fund, and could be sold, to some degree, in either an over the phone or in a webinar type of environment, that we could ship those deals and customers would accept them in volume.

If you are talking about a $2 to $500,000.00 piece of software, that typically requires an extensive review and maybe even board approval. But if you are talking about a $50 to $100,000.00 software obviously the smaller the deal – many times these are departmental approval levels and we can get them through a company’s approval cycle very, very quickly.

That was an eye opening experience for us and as a result we made a conscious decision three years ago to start packaging a number of our enhancements and additional products in that same vein and you are just seeing now the result of that. As we package a number of different offerings this way you are seeing customers accept them and we expect this to continue. In fact we are counting on it to continue, particularly in the second half of this fiscal year.

Brad Stills - Barclays Capital

Okay good and good progress on the services margin this quarter, quarter-on-quarter, but it sounds like it is not where you want it and you see directionally that going higher. Is it just simply a matter of staffing more hours to Manila? I know that is part of the goal, but is it that you need to find more consults in Manila or you need to ramp up what you already have there? Or is it simply just a case of staffing and utilization?

Harry Debes

It is not all about Manila, I just want to tell you that. Certainly, on the Manila front, that is part of the story. On the Manila front we are very pleased that every quarter the number of hours we deliver from there is improving and we are getting great customer success stories from the work that those folks are doing. So that is all positive. But, what we have done is we have created a capacity that isn’t utilized to the extent that we would like it to be at this point, so maybe we staff too quickly. I don’t know. Maybe we haven’t done a good enough job of educating our project leaders and various persons around the world of how to use Manila effectively, but clearly that’s an initiative that Eric has on his plate. That is just one part of the story.

I would tell you that in different parts of the world also there is a utilization issue, there is a pricing issue, and there is just also, in some cases, a cultural issue. Don’t forget that again, in the former Intentia, it was probably primarily a services business, frankly. About 60% of the business was services.

What we are saying is that we are more of a software company than we are a services company. We acknowledge and accept that services is an integral part of what we do, but there are other things we do that are also important and we just need to understand how to work together and, as we mentioned before, part of that strategy is to have a part in the ecosystem. So, as we are going through these sort of dynamic changes some of that just needs to just be understood and absorbed by local management and local staff, and I think we have some work left to do there.

Operator

Your next question comes from David Bayer from Cantor Fitzgerald.

David Bayer - Cantor Fitzgerald

I would like to sort of go into, and I think some people have delved into it already today, but I think there is just a little bit, in that we tend to certain revenues in the related cash flows from them. What the AE headcount reduction, I just wanted to know if in a sense we are hurting the development of the pipelines. I realize that we had some deferred deals, but it seems like a significant portion of the business is moving towards working with the installed base and I am just wondering if we have cut to the bone too much on the AE side in terms of expanding to new customers. Could you give us a little bit of color there?

Robert Schriesheim

First of all, as you can imagine, in any organization where you have 200 sales persons not every one is performing up to the level that you expect them to do. Obviously we look at that question first. Do we have some non-performers or some people who we don’t believe are going to be able to deliver on their commitments or on their targets in the long term. That is the first thing we look at.

Secondly, in a normal environment when you cull your sales organization you replace them immediately. In this environment, given that we have been observing a slow down in demand and we are not convinced as to when that is going to be turning around, we simply haven’t replaced them. I think if we had, if I was telling you today hey great news, we’ve gotten 220 AE’s compared to – everybody on this call would probably be asking me what I was doing. What are we doing here?

So, what we have done is we have taken the conservative view which is right now, at this stage, it is probably not the best idea in the world to increase our costs, because hiring new AE’s today means they are not going to be productive for at least nine months. Is that what our shareholders would like us to do or is that the right thing for our business to do when demand at this point is uncertain? In fact you could say the opposite. You could say demand is weak, probably weaker today than it was some time ago. So for those reasons we haven’t replace the AE’s we culled. But, every performance organization knows that you do periodically review your headcount and say who is a keeper and who is not and that is what we did.

David Bayer - Cantor Fitzgerald

That makes sense to me. The second line of question I have has to do with some thoughts just sort of magnitude wise on cash flow levels for the year as a whole. Did you think that they would be down sort of a meaningful percentage from last years cash flows as a whole or is your goal just to keep it reasonably closer? Could you just give us a little color on that?

Then related to that, I realize that you have not talked about Q4 explicitly, but do you think it is in terms of less ups in terms of Q3 than it normally has been or could you exceedingly be flattish or even down or just any thoughts at all on that? Obviously you are looking at a pipeline at some level. I would appreciate your thoughts along those lines.

Robert Schriesheim

On our cash flow, our cash flow is really largely driven by our maintenance collections cycle. Since our maintenance business is in very good shape, I don’t really see much change between last year and this year in our cash flow. That is a pretty direct response that should answer your question. I just don’t see any change.

Harry Debes

On Q4 David, we expect Q4 to be stronger than any of the quarters we have had, but will it be as good as last year, probably not. Last year was actually exceptionally strong. I recall $51 million of contract in the last year, we really exceeded every target that we set for that quarter and so it is very unlikely that we will get to that same level; however we do it still. And, because our customers understand the buying cycles many of our AE’s have worked deals to coincide with Q4. That is in a time when commission rates are at their highest, so like most software companies we still expect Q4 to be pretty strong.

But, you know what, we are just reluctant to give specifics at this time, because lets get through Q3 and then we will update you in March when we have our call.

David Bayer - Cantor Fitzgerald

No, I certainly understand that. When you think about your budgeting for the out year, are you kind of thinking about maybe small growth year-over-year or do you have any preliminary thoughts there?

Robert Schriesheim

No. Listen, I appreciate the question. We are all kind of smiling at each other, because we appreciate you are in that business and I guess I wouldn’t respect you if you didn’t ask that question, but we are just not in a position at this point where we want to even give preliminary thoughts on fiscal year ’10. We are obviously, as I indicated before, in this environment it is challenging enough to give visibility for the full year.

Harry Debes

Unless you can tell us what the economy is going to do, and what the exchange rates are going to do, and what the stimulus package is going to do, and how the banks are going to do. You can ask all those questions when we are able to answer the first one, but we just don’t know. It is just too difficult to predict at this time.

Robert Schriesheim

I just don’t think it would be helpful to the company or to any of our constituents, anyone in the investment community, for us to begin commenting on fiscal year ’10.

David Bayer - Cantor Fitzgerald

Okay, got it, thank you.

Barbara Doyle

Other than currency, David, the biggest impact we are seeing in our business is very specifically driven by the economy. So, until there is more clarity on the overall global macro economic condition it is very hard to predict.

David Bayer - Cantor Fitzgerald

Okay well let’s hope things improve for you and for the economy as a whole.

Barbara Doyle

Well in the meantime we are very focused on the margins and continue to deliver on our margin goals. Those are the things we can control.

David Bayer - Cantor Fitzgerald

Thank you very much.

Operator

There are no further questions.

Harry Debes

Just in closing then, thank you for joining us today. On behalf of everyone I would like to thank our employees, first of all, for working through what is a difficult time. In Q2 we had a restructuring; we had to take some tough measures. It is always difficult when you have to lose employees because the economy is uncertain and for the good of the business as a whole we had to make some tough decisions.

We also thank our customers for their on going support. I think our management team for having helped us work through a very difficult time and as Barbara mentioned, we are very much focused on our operating margin, making sure that even in this difficult time, for the full year our operating margin is delivered at a better rate than what we ended last year. I think if we accomplish that then I think we should all feel good about the work we have done.

Thank you and we will see you on the next earnings call.

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