Lawson Software, Inc. F2Q10 (Qtr End 11/30/09) Earnings Call Transcript

Jan. 7.10 | About: Lawson Software, (LWSN)

Lawson Software, Inc. (NASDAQ:LWSN)

F2Q10 Earnings Call

January 7, 2010 5:00 pm ET

Executives

Barbara Doyle -Vice President of Investor Relations

Harry Debes - President, Chief Executive Officer

Stefan Schulz - Chief Financial Officer

Analysts

Mark Murphy - Piper Jaffray

Peter Goldmacher - Cowen & Co.

Richard Williams - Cross Research

Tom Ernst - Deutsche Bank Securities

Mark Schappel – The Benchmark Company

Brad Sills - Barclays Capital

Operator

Welcome and thank you for holding. (Operator Instructions) I would like to turn the call over to Barbara Doyle. You may begin.

Barbara Doyle

Good afternoon to everyone on the call. Welcome to Lawson Software's fiscal second quarter conference call covering the quarter ended November 30, 2009. With me as always on today's call are Harry Debes, Lawson's President and Chief Executive Officer and Stefan Schulz, Lawson’s Chief Financial Officer.

After completing our prepared remarks we will talk your questions as the operator described. Before we get to our quarterly results I would like to review our Safe Harbor statement.

We would like to remind you that this call will include forward-looking statements which are subject to risks and uncertainties. These forward-looking statements contain statements of intent, belief, 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 today. Our SEC filings contain further information about the risk factors that could cause actual results to differ from management's expectations. We do not obligate ourselves to update forward-looking statements for circumstances or events that occur in the future.

I would also like to 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 in our press release.

Lastly, we have a supplemental summary of historical key business metrics on our website for your use. You can find these at www.lawson.com/Investor.

Now let me turn the call over to Harry Debes.

Harry Debes

Thank you Barbara and good afternoon everyone. I will begin with some high level comments on the results of our second quarter focusing on our sales metrics. After that Stefan Schulz, whose appointment to CFO was announced in December, will summarize the financial highlights for the quarter and provide guidance for the third quarter. In my closing remarks I will discuss the acquisition of Healthvision Solutions which was announced today and then we will take your questions.

Here are the highlights of our second quarter. During the quarter total revenues were $184 million and that exceeded our guidance. Non-GAAP earnings per share were $0.09 and that was at the top end of our guidance range. We increased non-GAAP operating income by 7% year-over-year and achieved mid teen’s operating margins for the fourth consecutive quarter.

Now for some specifics regarding software sales. The total value of license fee contracting was $27 million and that is an increase of 10% from last year. License revenues, however, of $28 million decreased by 6% year-over-year due to a slightly higher revenue deferral rate in some of our larger deals. As those of you who follow us know a certain percent of this happens every quarter. There is nothing unusual about the deals that were deferred and they will be recognized in the coming quarters as we complete the implementation.

Total deal volume was up slightly compared to last year and that was encouraging. Sales productivity and the 90 day pipeline win rate both improved sequentially. I believe that our improved sales performance is partly due to an economy that is beginning to stabilize and partly due to our vertical go to market strategy. By being more focused on those verticals in which we have core strengths we are putting ourselves in a better position to win our sales engagements.

Now here are the key sales metrics for the quarter. We signed 257 total deals compared with 256 last year. 18 of these deals were with new customers compared with 16 last year. 40% of our total contracting in the quarter is with new customers compared with 20% last year. We had three deals greater than $1 million compared to two in Q2 2009. The average selling price of new customer deals increased to $620,000 from $290,000 in Q2 2009 and this was primarily due to a few large ESM&R deals. The average selling price for all deals in Q2 is up 10% to $106,000 versus $96,000 in Q2 of last year.

Looking at our segments, we had good license contracting and revenue performance in several areas. License revenues increased by 9% in our M3 segment primarily due to continued strong performance in our equipment services management and rental business. We signed our 11th Caterpillar dealer in Q2, [Intek] in Australia. We had another key win at [inaudible] Industries in Sweden.

ESM&R sales and activity continues to validate the strength of our unique solution that helps equip the dealers to improve their operations. In the S3 segment, license revenue declined slightly from a very strong Q2 2009. However, our healthcare and public sector businesses have performed well during this economic downturn. We signed two S3 deals that were greater than $1 million; Cook Children’s Healthcare System in Chicago and Tucson Unified School District. This is the third consecutive quarter where we signed a $1 million plus deal in the public sector and is due to the many public sector customer case studies that demonstrate the significant cost savings.

Overall I would say that when it comes to software purchases business conditions are not as rosy as they were 18 months ago but based on our pipeline and sales activity we believe there are some real signs of a gradual recovery.

Now moving onto product innovation, we are pleased to announce that our next release of M3, M3 10.1 will become generally available in February 2010. This release adds more vertical functionality to the product line including the introduction of Lawson For Fashion and our second release of ESM&R. New features for Lawson for Fashion include integrated assortment and replenishing, new style color functionality, advanced sourcing capabilities and improved support for bulk orders and order regrouping.

The new release for ESM&R 1.2 contains new analytics, new warranty and claims management, sales order integration, an enhanced customer portal as well as Quick Step for ESM&R. There are more than 100 feature and functional enhancements in this new release and we will begin to sell and ship that in our fourth fiscal quarter.

So here are the three take away’s regarding the quarter. First, the economy is beginning to stabilize and this is helping us to sign new license business. Second, we continue to see positive signs that our vertical strategy is working. Pipelines and close rates are gradually improving because we are more focused and more effective at winning our targeted sales engagements. Third, our business transformation is mostly complete and we are now comfortably able to run the business on a much lower cost base.

That summarizes the highlights for Q2. As I said before I will discuss the Healthvision acquisition in my closing remarks. I now will turn the call over to our CFO, Stefan Schulz, for a more detailed review of our key financial performance and also for our guidance for the third quarter.

Stefan Schulz

Thank you Harry. Good afternoon everyone. I will begin with a summary of our non-GAAP income statement results first.

Total revenues of $184 million exceeded the high end of our guidance range of $175-180 million. Revenues declined by 11% as reported or 12% adjusted for currency fluctuations. Currency fluctuations did not materially impact non-GAAP profits or EPS in the quarter. We saw some decline in all lines of revenue this quarter which is consistent with economic conditions over the past year.

Software revenues, comprised of license and maintenance declined by 6% or 5% adjusting for currency. Consulting revenues were down 18% or 22% adjusted for currency. Harry has already discussed our license revenue performance and related metrics so I will focus on consulting and maintenance.

Q2 consulting revenues of $71 million were down 18% as reported or 22% adjusted for currency. Lower services revenues are the result of resizing our consulting business over the last year. As we have discussed, we reduced the size of our consultant team by 30% in light of the current economic conditions and in light of our strategy to utilize more services partners so the impact to revenues was forecasted and is not a surprise.

The more pertinent measure for services though is margin which has increased by 200 basis points year-over-year to 17% on a non-GAAP basis. This increase reflects the focus on our consulting business over the last year. 17% margin is one of the better margin performances in our software peer group at this time so we are pleased with the progress we are making in this part of our business.

Maintenance revenues of $85 million were down 5% as reported or 3% adjusted for currency. Q2 results were impacted by a combination of factors including pricing pressure relative to our annual rate increase expectations and some cancellations due to the current macroeconomic climate. As many of you know we have two primary renewal cycles; Americas customers in June and international customers in January. For the renewal cycle just completed in the Americas, we experienced a renewal rates in the low to mid 90’s which is slightly less than prior years. We expect a similar trend with our upcoming international renewals and some further downward pressure on maintenance revenue. However, total maintenance renewal rates remained in a healthy position in the low 90’s.

Moving on to operating margin which I think is a good reflection of the improved strength in our business. Q2 non-GAAP operating margin of 15% was up from 12% a year ago. This is our fourth consecutive quarter of mid teen’s non-GAAP operating margin which demonstrates the increased level of core operating profitability in the company. In addition to the margin improvement the absolute dollars from operating income were up by 6% from a year ago to $27 million.

We have pointed this out before but it bears repeating. We have driven sustainable improvement in our operating profitability as a result of efficiencies we have created through streamlined global operations rather than through arbitrary or across the board cost cuts. You can see clear supporting examples of this in two areas within our reported results.

First, through earlier investments in our infrastructure such as implementing our Lawson Financial and Human Capital Management Systems globally, we have started to standardize processes and centralize operations to eliminate cost redundancies across the company, all helping to lower our G&A expense. Our non-GAAP G&A costs in Q2 of $19 million were 14% lower than Q2 of last year and 21% lower than Q2 2008.

Second, the resizing of our services organization has enabled our services team to better leverage our partner network and adequately support the market demand for these services. Our services margin of 17% in Q2 fiscal 2010 increased from 15% a year ago and matches the margin performance in Q2 2008 when we had greater scale and services with revenue exceeding $100 million a quarter.

We did not lower our spend in R&D. Our Q2 R&D costs of $22 million are relatively flat to last year and are up slightly from Q2 2008. As we pointed out at our Analyst Day in November we have 20% more R&D employees and product development capacity than we did three years ago. To be fair though when demand for software licenses fell over the past year we did allow our sales costs to decline and held marketing budgets flat.

However, as we discussed last quarter we have begun to increase our sales force. This is reflected in our Q2 expenses and you will see this trend in future quarters as well. I make these points because we feel very good about where we are operationally as a company. Our improved level of operating profitability positively impacted our EPS compared to last year.

Moving down the income statement we did have some offsetting impacts below the operating income line. Lower interest income continues to negatively impact our EPS relative to fiscal 2009. Even though our average cash and investments were up $58 million over last year our interest income of $245,000 was 1/10th of what we earned last year as current yields are virtually zero percent. Our non-GAAP effective tax rate of 37% for fiscal 2010 is up marginally from 35% last year. The loss of interest income and the slightly higher tax rate more than offset our operating income improvements in the quarter. Combined these items totaled $0.01 per share driving the year-over-year decline in our non-GAAP EPS.

Turning to the balance sheet and cash flows, our cash and investments balance at quarter end was end was $371 million including $10 million of restricted cash. We have $146 million of cash net of debt. Total deferred revenues were $193 million including $46 million of deferred license revenues. The deferred license revenue balance declined less than $1 million sequentially from Q1. Deferred maintenance revenue balance declined to $132 million from $197 million in Q1. The sequential decline in deferred maintenance is consistent with the seasonal pattern of our renewal cycles.

Cash flow from operations was a negative $32 million in Q2. I will remind you our quarterly cash flow is heavily skewed by quarter given the timing of our maintenance contract renewal cycles. Maintenance contract renewals and collections are large drivers of cash flow for us and for most software companies. Cash collections from maintenance renewal cycles occur mostly in the second half of our fiscal year. As a result our cash flows are negative in our first and second fiscal quarters and highly positive in our third and fourth quarters every year. Q2 is always the low point in our fiscal year. This has been our pattern for three years now so it should be familiar to most people but it deserves a reminder.

You will note, however, that our cash flow from operations improved by more than $11 million compared to last year’s Q2 and by $6 million on a six month year-to-date basis. We also continue to anticipate that our cash flow from operations for the full year will exceed the fiscal 2009 levels driven by higher income and improvements in our working capital.

Now let me cover our financial guidance. Our guidance estimates in this discussion do not include any impact associated with our acquisition of Healthvision. I would point out that Healthvision is not anticipated to materially impact non-GAAP EPS in Q3 assuming it does close in the quarter as planned. We will include Healthvision’s estimated results in our Q4 guidance that we will provide on our next earnings call assuming the transaction closes in our February quarter.

For Q3 fiscal 2010 we anticipate total revenues will be between $174-178 million. We estimate GAAP EPS to be in a range of $0.02 and $0.04 per fully diluted share. Our non-GAAP EPS is expected to be between $0.07 and $0.09. This range is based on average currency exchange rates during the month of December. Our Q3 non-GAAP EPS guidance of $0.07 to $0.09 compares to $0.10 in the same period last year so let me add some color here.

First, currency fluctuations are expected to negatively impact our bottom line by $0.01. Although the US dollar has strengthened recently it is down by 16% versus the Swedish Kronor and by 11% versus the Euro and the British Pound compared to this time last year.

Based on average foreign exchange rates in December which we are using for our Q3 guidance, currencies will increase our expenses by $9 million compared to last year which is $2 million more than the increase to revenues.

Interest income and taxes will also negatively impact Q3 EPS by about $0.01. Our quarterly interest income is down nearly $2 million year-over-year which has a material impact on net earnings.

Lastly the slight erosion on maintenance renewals I discussed earlier will start to put some pressure on our EPS. Our current estimate is that Q3 maintenance revenues could be impacted by $1 million compared to last year so we are factoring this into our guidance range. If we see the same trends in our international renewal cycle currently underway we could see a larger impact in Q4 and in fiscal 2011.

So that is a summary of our guidance. Before handing the call back to Harry I will wrap up by saying that our Q2 and first half financial results are solid, exceeding expectations overall especially in this economy. We still have some challenges ahead of us so it is not all smooth sailing. Our accomplishments over the last three years provide us with great confidence going forward. I say this because we have established a much stronger operating base for the company. We are able to operate at a higher profit level while making important investments in our infrastructure, our products and in sales and marketing resources for our key industry verticals.

In addition, our newly implemented vertical model provides us with the visibility to target our capital allocations to areas that will maximize our return. Overall, I think we are well positioned to not only deal with the choppy economic recovery but also to grow in our strategic markets.

Now let me hand the call back over to Harry.

Harry Debes

Thanks Stefan. Let me congratulate you once again on your promotion. It was very well deserved. For several quarters now we have been telling you we plan to grow our business both organically and also through acquisitions. We told you we have been very disciplined as we evaluated various acquisition opportunities. Our patience has been rewarded and in the Healthvision transaction we believe we have found a deal which meets all of our criteria. Let me take you through that.

First, this is a very strategic acquisition for Lawson because it expands our solution footprint in healthcare where Lawson is already an established market leader. Healthvision also extends our capabilities and puts us squarely in markets that are targeted for healthcare IT investments and reform. One of the big problems in the healthcare market is that there is no single solution provider, one vendor who has developed a comprehensive solution to meet the needs of hospitals and clinics.

As a result a typical hospital uses more than 200 different applications from up to 100 different software vendors. This causes complexity and that means higher costs. Healthvision has three product lines that help to reduce some of this complexity, lower costs and thereby add value.

First is the Cloverleaf Integrated Suite which connects the [inaudible] software and technology used throughout a hospital enabling information to flow smoothly to the healthcare professional regardless of the data source. Cloverleaf is Healthvision’s flagship technology currently installed in 33% of hospitals in North America.

The second solution set is the Health Information Exchange Platform. This is a hosted solution that links broad healthcare networks including hospitals, physicians, labs, pharmacies, payors and vendors. It allows the sharing of patient data with streamlined processing and increased accuracy. HIE’s are an emerging market at the forefront of healthcare reform and investment.

The third solution is an integrated suite of applications for electronic health records, patient management, lab and clinical systems and also public community care applications. It is called MediSuite and it has been specifically designed for the Canadian healthcare market.

So between Healthvision’s integrated technology and Lawson’s ERP applications, Lawson can now offer a broad set of products to help hospitals and healthcare providers of all sizes run their organizations more efficiently from the management of their supply chains to staffing and scheduling, to financial processes to better integrate their IT environments.

The second reason this is important is that Healthvision gives us more critical mass and therefore a greater market share in one of our most important medical markets. This acquisition adds 800 customers in the United States, Canada and China to Lawson’s existing 650 customers. Only 25% of Healthvision’s customers are running both Lawson and Healthvision products thereby giving us an excellent cross-sell opportunity. Combined we will have 1,200 discrete customers and that represents approximately 7,000 hospitals around the world.

The final reason, from a financial perspective Healthvision is expected to add $60-70 million of annual revenue of which about 60% is recurring maintenance and subscription. This results in an approximate increase of $7 million of maintenance revenue and $3 million of subscription license revenue per quarter. This business is already profitable and should be accretive to our earnings by adding $0.06 to $0.07 of non-GAAP earnings per share in the first 12 months after close.

The bottom line is we have taken our cash out of the bank where as Stefan said it is earning us virtually no interest income and we have put it to use to create immediate shareholder value. In summary, we are very excited about this addition and expect the transaction to close within a few weeks pending regulatory approvals.

In closing, I would like to point out that our business performance in the first half of our fiscal year has exceeded the goals we set. Despite the recession our non-GAAP operating income increased by 43% in the first six months in one of the toughest business environments I have seen in my career. This performance reflects the focus and hard work of everyone in the company and for that I am very grateful.

We also chose this time to reorganize the company along vertical industries. Today the vertical business model is well established and deeply engrained in all aspects our company. This structure allows us to target capital investments that have meaningful impact where we see the greatest potential.

The acquisition of Healthvision is a logical extension of that strategy in action. Another example is the organic development of our ESM&R solution which now has generated more than $30 million of new license revenue in the last 24 months. Our ability to more strategically focus on capital makes us a stronger company and our added vertical capabilities provide solutions that help us deliver on our mission which is to make our customers stronger.

Operator that concludes our comments. We are ready to take some questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Mark Murphy - Piper Jaffray.

Mark Murphy - Piper Jaffray

On the commentary that the license contracting was up year-over-year I think that is for the first time in about 4-5 quarters. Are you looking at this possibly as an inflection point I guess notwithstanding your commentary you think what is happening is gradual and you think the license contracting has bottomed?

Harry Debes

No. I will tell you I think it has certainly is an inflection point in our second quarter. We think it will also strengthen in our third quarter. In the fourth quarter we have some pretty tough comparables because we had a pretty good fourth quarter last year and I can’t give you visibility for that. In general, the signs we are seeing in terms of deal activity, deal flow, close rates it is certainly encouraging.

Mark Murphy - Piper Jaffray

On Healthvision it looks like this is more data integration infrastructure than applications. Historically obviously you have provided applications mostly and much of your infrastructure offering has been provided by third parties. My question is what is driving the decision to move like this in a big way into infrastructure? Do you think there is a changing dynamic where both of those layers need to be provided by the same vendor? Also, do you have a plan to do this in some of your other focus verticals like public sector?

Harry Debes

First let me point out there are three elements of the Healthvision solutions set, two of which address infrastructure. The third, MediSuite, is actually an applications play. Secondly, the integration capability isn’t hardware or technology or space. It is software. We are not selling networks or physical devices. We are selling software but it is integration software. We believe it is important because this is where a lot of the activity is forecasted to come in the next couple of years and also there has been no one who has stepped forward to claim this particular space. There is no clear leader. Healthvision could have made a claim as being among the leaders. We think that together with Lawson we can claim that ground probably in a year or two to be a leader not just in the ERP space which we are today but also to be the leader in tying all the different systems together. Clearly it is a pinpoint for our healthcare customers.

They are looking for solutions. They are looking for fewer vendors to tie all these different solutions together and we think we can deliver that. We already have great working relationships with most of them anyway.

Mark Murphy - Piper Jaffray

I don’t know if you have this handy, but can you approximate how much whether Healthvision had a positive net cash balance on their balance sheet?

Stefan Schulz

They did have a positive cash balance on their balance sheet.

Mark Murphy - Piper Jaffray

Was it material?

Stefan Schulz

No but as you might imagine that is not really going to be coming to us. That is all netted out in the purchase price.

Mark Murphy - Piper Jaffray

So I guess thinking about it that way it looks like the purchase price is around 2.5 times what you are looking at for first year revenues. Lawson is not trading at that kind of a multiple. I guess any color on how you thought through that valuation multiple and perhaps part of the answer is because there is all that recurring revenue is that first year revenue approximation on kind of a steep trajectory because of the accounting work? In other words is it possible that year two is materially higher revenue forecast?

Harry Debes

First of all you are right on your estimate that it is about 2.5 times revenue. However, you should also be aware that the healthcare space valuations are different than valuations in classic ERP. That is the first thing. Secondly, this is a pretty profitable business today. That has an impact and a bearing on when you put the valuations together. It isn’t strictly multiples of revenue to determine a valuation.

So we took that into consideration as well. We do think first of all it is a profitable business. It is a strategic business. We think it is a business that will grow in our hands and we think it is going to add tremendous value to the Lawson company.

Mark Murphy - Piper Jaffray

I believe the prior guidance for the fiscal year called for 8-10% growth in the pro forma EPS and I guess it is not clear to me at this point whether that is still valid or at this stage are you not guiding on full year?

Stefan Schulz

We are not changing anything we have said in the past. No changes at this point.

Operator

The next question comes from the line of Peter Goldmacher - Cowen & Co.

Peter Goldmacher - Cowen & Co.

I just wanted to talk a little bit more about the deal. So 60% of the business is maintenance and subscription. What is the other 40%?

Harry Debes

Some of it is software and some of it is services. About half and half. Perpetual software.

Peter Goldmacher - Cowen & Co.

So is this company in the midst of transitioning a perpetual business to a subscription model so we can expect that perpetual business to go towards zero and move towards subscription?

Harry Debes

No. We think that all four revenue lines will continue.

Peter Goldmacher - Cowen & Co.

So when I look at your guidance and I forecast it out it looks like stand alone Healthvision can do about a 25-26% operating margin. What are the margins now?

Stefan Schulz

They are pretty healthy. I don’t think we want to give that out. It is a private company. They are pretty healthy. We are pretty happy with the numbers that they do. By the way, just as a follow-up to your first question one part of their organization, there are three parts, one part the HIE the healthcare innovation piece. That is a subscription piece. The other two pieces are perpetual in nature.

Peter Goldmacher - Cowen & Co.

So the HRE is that the infrastructure or the app?

Stefan Schulz

There are two infrastructure pieces. Cloverleaf and HIE. The apps are MediSuite.

Peter Goldmacher - Cowen & Co.

HIE is the subscription?

Harry Debes

Subscription.

Peter Goldmacher - Cowen & Co.

The other two are…

Harry Debes

Perpetual.

Peter Goldmacher - Cowen & Co.

So when you talk about selling infrastructure…I hear infrastructure and I immediately think a big consulting engagement. How does that change the way you have been de-emphasizing your services business? Is this incrementally appealing to your partners because now they can build out their practice and get more work? Are you planning on having to deliver more of those services yourselves?

Harry Debes

Only 20% of Healthvision’s revenue is services. We don’t see that changing in our hands dramatically. They do have services partners and we would expect to continue to work with those partners. They also have resellers of their solution set. Some of them are like GE Healthcare who is part of that reseller network. There are resellers in Asia and resellers in Europe. We plan to continue to work with those resellers so they take on much of that services work. This is not a change in strategy as far as the Healthvision go to market strategy at all.

Peter Goldmacher - Cowen & Co.

Do you think any of their integration partners are capable of doing some of the core Lawson integration? Is it another avenue to market for those guys?

Harry Debes

It is possible. I don’t think we can definitely say that because we have not engaged with them. As you can imagine it has been confidential but it is certainly possible.

Peter Goldmacher - Cowen & Co.

How does the complexion of the sales force change when you are talking about selling core Lawson is generally ERP and now you are getting into patient data and a more technical sale? I don’t imagine there are synergies in the sales force and I would imagine you are going to keep the Healthvision sales guys? Will you be adding sales guys? How are you going to manage multiple Lawson sales guys in an account and that potential issue there?

Harry Debes

There are about 12 AE’s that come to us from Healthvision. Between now and the end of the fiscal year we see virtually no change to our sales force or their sales force. However, we do believe in the future we can expand our sales force to carry more of Lawson’s products and also Healthvision’s products going forward. We also think that in many cases, not all, but in many cases our existing Lawson sales people can represent our existing license people can represent the Healthvision solutions as well and vice versa.

Peter Goldmacher - Cowen & Co.

When I read part of the blurb in your press release and you talked about the multiple different constituents that the data you are integrating you are talking about payors and labs and clinics, will you need to maintain a relationship with the technology aspect of those businesses to make sure the data flows freely? What is the embedded infrastructure cost on something like that?

Harry Debes

Those relationships and those integration points are already built out. Aside from normal maintenance and upgrades to the tool set and the technology environment set there isn’t anything extraordinary that has to happen because they already have, as we said, 800 customers. Those 800 customers represent something like 3,000 to 3,500 hospitals. It is not like we are going to find a new major vendor out there that we haven’t already connected to.

Peter Goldmacher - Cowen & Co.

So if you look at the customers they have and the customers you have is it a logical overlap or do they sell to a segment of the healthcare market that just wouldn’t need your ERP?

Harry Debes

Surprisingly it is only a 25% overlap. I would have thought it would have been a greater overlap. As we got further into this we found that one of the reasons is that they have a considerable number of customers that are international or global whereas in the past we have really focused on the US market. For example they have quite a few customers in Canada. We have half a dozen customers in Canada. They have customers in Europe. Three customers in Europe. They have customers in Asia. We have none in Asia. I think there is a potential for us to expand our solution set.

Peter Goldmacher - Cowen & Co.

So of the customers they have are they all potential Lawson ERP customers or are they in a considerably different…are they selling to a different end market?

Harry Debes

The only thing that might exclude them as a potential Lawson customer would be a geographic element. For example, our ERP solution today for healthcare wouldn’t work in China as an example. It would work in Europe and in fact we have it working in Europe. It would work in Canada. We have it working in Canada. But certain geographies they would probably not work in. However, in terms of the size of customer or the nature of the organization when comparing their base to ours there is no reason for it to be excluded.

Peter Goldmacher - Cowen & Co.

So if we scan back to the core [inaudible] and it was about a $50 million a year business in 2007 and now in your guidance we take the midpoint it is a 9% top line grower, can we forecast that out for another 2-3 years? Is that number too high or too low?

Harry Debes

The deal hasn’t closed yet so we are not really in a position to give you good guidance on what is going to happen a year or two out. Let us close the deal. Let us get the third quarter and integration work done and then at the end of our third quarter we will probably be in a position to be a bit more clear and certainly by the end of our fiscal year as we give guidance for the full year we can be a lot more precise and help you out. We would love to give you more but at this point I think we still have to wait until the deal gets closed.

Operator

The next question comes from the line of Richard Williams - Cross Research.

Richard Williams - Cross Research

I wonder if you could remind us on the maintenance drop off. I think you mentioned that last time but just the dynamics of the maintenance renewal rates coming down a little bit?

Harry Debes

As Stefan said there were two factors that had to do with the maintenance. The one factor was we were renewing our S3 maintenance revenue and the renewal date was May 31st which means we sent the invoices out in March and April of 2009. If you remember back March and April of 2009 was the bottom of the recession. Everybody was hurting. Everybody was uncertain. People were nervous about the future. People were cutting costs.

Therefore those customers in some cases, and frankly unprecedented, did in a few instances eliminate maintenance. They did not purchase a competitor’s product. They did not go to a third party maintenance provider. They simply took a chance. It is like you not renewing the insurance on your house because you have a choice to make. Either make the mortgage payment or pay the insurance on your house. They chose not to pay maintenance.

Richard Williams - Cross Research

So it could come back then?

Harry Debes

That is just the first point. We had a 1% lower renewal rate than we have had historically. The second reason is every year we have a price increase on maintenance. This year we had a price increase as well and that was baked into our plan. However, as we were negotiating and as we were observing in some cases people were really up against the wall and could not afford the full price increase in some cases we negotiated a lower price increase. Those two factors together account for 99% of the reduction.

Richard Williams - Cross Research

Shifting gears, could you run through the different geographies and give us some color on the selling environment and what you are hearing from customers on the economy?

Harry Debes

As I said I think generally speaking we see positive signs in the economy. I would say that would be across the board. In Asia the economy was never quite as bad or if it was bad it recovered very quickly. I would say it even recovered in our first quarter. In the second quarter we saw pretty much an across the board improvement especially in our M3 business which was much stronger in our second quarter than it was in our first quarter. That is not a big surprise. The second quarter is always a bit stronger but we did definitely see deal activity and deal engagement pick up and frankly we are pretty pleased about the contracting.

Never mind the sequential quarter-to-quarter number because we always know Q1 is relatively weak and Q2 by definition is stronger. But let’s look year-over-year Q2. That was up. That was much stronger. So we are pretty pleased about that and we think we have some momentum going into Q3. Once again we will be strong. That is across the board by the way. I don’t want to…is it strong in Spain? Not it isn’t strong in Spain but we don’t have a lot of activity based on Spain anyway. In the major markets, France, Germany, the U.K., Sweden, the US, those are all pretty strong.

Richard Williams - Cross Research

Switching gears again, Cloverleaf, is that primarily a middleware solution or how does that work?

Harry Debes

It is a middleware integration solution. That is correct.

Richard Williams - Cross Research

What kind of timeframe do you anticipate assuming the deal closes to fully integrate Lawson products into Cloverleaf?

Harry Debes

Here is the good news. They are already integrated. We have 200 customers in common. Guess what that means, our solution is already connected through Cloverleaf to the other applications. Cloverleaf is the glue that binds us together. So really in terms of integration effort we have very little to do. Now we may decide there are opportunities to strengthen the bond that already exists and perhaps even give ourselves an unfair advantage in terms of integration. There is a novel idea. The good news is that for 200 customers we already co-exist very nicely.

Richard Williams - Cross Research

So the synergies as it relates to Cloverleaf is just bringing both Lawson and integration products to a wider audience?

Harry Debes

Yes we think so.

Operator

The next question comes from the line of Tom Ernst - Deutsche Bank Securities.

Tom Ernst - Deutsche Bank Securities

A quick follow-up at this point. Post the deal you will still have $200 million in cash and you will have your strong cash flow quarters coming up. The deal obviously is highlighting for us as part of the strategy baked in with what you highlighted at the Analyst Day. Do you do one at a time here or do you think you can support other vertical market add on acquisitions at the same time as well? What has changed in the strategy from what you outlined at the Analyst Day in terms of your acquisitions?

Harry Debes

I will answer the second part of your question. I will let Stefan address the first part of your question on the cash. It is possible we could do more than one deal at a time but frankly we think it is prudent to do one of this size and then we may start thinking about another one but as we have always said we have a pretty high bar for acquisitions. We have eliminated in the last 2-3 years, filtered out I am going to say somewhere between 50-60 potential acquisitions that for a variety of reasons did not meet our criteria. So to you and the rest of the community that follows us should feel some confidence that when we pull the trigger and do something it is going to work out. We are not lowering the bar in the future. The bar remains high.

If we find deals that are going to fit our strategy, expand our markets and expand our footprint and be accretive to the business and be financially acceptable we will do them. I think we have the means both financially and from a management bandwidth to do them but at this point we are focusing on making sure that the Healthvision company integrates well into Lawson and that we deliver and/or exceed all expectations that we have for that before we engage in another deal. Now I am going to let Stefan talk about cash and cash flow and all those kinds of things.

Stefan Schulz

Your math was exactly right. We are going to be a little north of $200 million if you look at the numbers we had at the end of Q2. You are also right, our cash will grow in Q3 and we are already seeing signs of that as we start to collect the maintenance renewals on the international side. We will keep an eye on that. We also know we have a convertible debt obligation that is out there and so that is in the back of our minds as well. We are going to look at ways in which we can fund any kind of strategic acquisition and really look at ways in which we can prohibit any sort of good opportunity from being an issue because of cash. So we are very pleased by the way with our cash flow performance in the first half of this year and I think you will see that we have really been focused on our working capital. That has been something we have been really focused on over the last several months and as you can see it is starting to pay off.

Operator

The next question comes from the line of Mark Schappel – The Benchmark Company.

Mark Schappel – The Benchmark Company

It was good to see the M3 business turned a corner and performed well. I wonder if you could provide some additional details specifically with the food and fashion business and how that did in the quarter?

Harry Debes

Both picked up significantly from Q1. Let’s not forget that we only really created this business in June. We are talking seven months ago or 6.5 months ago. So for us to create a global virtual business unit that focuses on a market and for us to get a brand out there and we changed people and changed target markets and assignments. That always doesn’t translate into instant results. Frankly although we were a little disappointed that Q1 wasn’t stronger. I guess we probably shouldn’t have expected it to be stronger. We integrated so much change.

In Q2 both food and fashion in particular, as you asked about those more than doubled their performance compared to Q1. ESM&R was strong in Q1. It continued to be very strong again in Q2. We see that continuing for some time. Those are the main growth drivers. By the way, one other thing, we don’t talk about this too much but our partner reseller channel has started to take off now as well. Maybe in the future we should give highlights on this a little more because we had some surprisingly good results from our reseller channel. We put a lot of effort into recruiting new reseller partners and in some cases in the geographies where we exist and in some cases in geographies where we don’t exist and that is starting to really have some traction. We are getting 3-4 deals a quarter now through this reseller channel. So that has all contributed to our success.

Mark Schappel – The Benchmark Company

On the sales front, how many quota carrying account executives did you end the quarter with?

Harry Debes

I believe it is about 169.

Mark Schappel – The Benchmark Company

So that is up about 7 from the prior quarter?

Harry Debes

It is up but it is still below our target. We are still hiring. Obviously we are giving you a net number because we add people at some times and also we take people out because their performance isn’t what we want or we get resignations.

Mark Schappel – The Benchmark Company

So that number is going to go north for the balance of the year?

Harry Debes

It definitely will.

Mark Schappel – The Benchmark Company

On Healthvision who would you consider to be their principle competitors?

Harry Debes

We have a list of their competitors but frankly none of them are as large as Healthvision and none of them are names that you would recognize. They are small, private companies.

Operator

The next question comes from the line of Brad Sills - Barclays Capital.

Brad Sills - Barclays Capital

You mentioned S3 being down slightly year-over-year but strength in healthcare and public sector. Were there certain verticals you saw weakness this quarter?

Harry Debes

Let’s just remember, what we did in June was we identified our growth targets and then we said customers who weren’t in those growth targets we would continue to support, maintain and deliver enhancements as we added new functionality to the core product and also as we added extensions to our core product. But, there is no point in talking about and it is not like we aren’t selling to other vertical industries but they are not strategic targets for us. That is why we don’t talk about other industries. We don’t plan to in the future. For example, we have about 100 customers that are what we would call professional services industry customers. We have about 100 customers that are in financial services. We have airlines.

We have all kinds of industries but the problem is that the whole message about our vertical approach is we cannot service 20-30 different industries adequately and therefore we have targeted a few that we believe we have a long-term vision for where we have a roadmap where we have a competitive advantage compared to SAP, Oracle and other players as we believe our win rates will be higher. So we can be more efficient. That is why we are going to give you commentary on our strategic verticals. There is no point in telling you guess what we found an airline. That happens every once in awhile but it is not our focus.

Barbara Doyle

The other thing I would add and you will see this in our 10-Q which will be filed today or tomorrow, we are talking about a very small amount of decline. $400,000. It is not marginal. It just happened to not be up for a change.

Harry Debes

I am very positive about it in Q3 by the way. We think it will rebound.

Brad Sills - Barclays Capital

One follow-on the deal, when you did your due diligence within the hospital installed base which of the three solutions did you find the most opportunity for cross-sell? In other words, was there a subset of customers within your hospital account base you saw particular demand for Cloverleaf or a MediSuite solution?

Harry Debes

We think Cloverleaf and even Healthvision would say Cloverleaf is their flagship product. It is the one that has the most appeal. It is the one that is most broadly installed. It is the one where we believe it has the most growth potential for us. I don’t want to minimize the other two but you asked which one of the three and I would say that is probably the one.

I am going to wrap up now. First of all I would like to say thank you to our customers and our employees for working so hard with us during a difficult time we have been through in the last 6-12 months. We are very pleased with the results of the business. We continue to head in the right direction. Q2 was a strong quarter right across the board. We think we can continue that momentum going forward.

As far as the Healthvision acquisition is concerned, we know there is a general tendency to be nervous when a company announces acquisitions but frankly folks we have I think earned our stripes. You may or may not know that the Intentia acquisition was complicated. It was challenging. It took a lot of hard work. On a scale of 1-10 that was a 10. On a scale of 1-10 we expect the Healthvision transaction from a complexity perspective or from a risk perspective is about a 1 or a 2. We feel that confident about this business. Therefore, I think obviously you will judge us on our performance which is completely fair but I would tell you right now we feel very good about this business, the people in that business, the customers in that business and the results we can deliver. So thanks for listening in today. We will speak with you in a couple of months.

Operator

This concludes today’s call. Thank you for your participation. You may disconnect at this time.

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