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Callidus Software Inc. (NASDAQ:CALD)

Q1 2010 Earnings Call Transcript

April 29, 2010 4:30 pm ET

Executives

Ron Fior – SVP, Finance & Operations, and CFO

Leslie Stretch – President and CEO

Analysts

Michael Nemeroff – Wedbush

Ian Calson [ph] – Northland Securities

Kevin Liu – B. Riley & Company

Ted Ketterer – TK Associates

Gregg Speicher – Moss Creek Capital

Bill Swanson – Northland Securities

Operator

Good day, ladies and gentlemen and welcome to the Callidus Software Incorporated first quarter 2010 earnings conference call. My name is Jennifer and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions) I would now like to turn the presentation over to your host for today's conference, Mr. Ron Fior, Senior Vice President of Finance and Operations and CFO of Callidus Software Incorporated. Please proceed.

Ron Fior

Thank you. Welcome to Callidus Software's first quarter 2010 conference call. With me on the call today is Leslie Stretch, President and CEO of Callidus Software. Shortly after the market closed today, Callidus issued financial results for the first quarter of 2010. The press release was posted on the Wire and is available on our website at callidussoftware.com.

We'd like to remind you that during the course of this conference call, we will make forward-looking statements, including predictions and estimates. These statements involve a number of risks and uncertainties including statements regarding our business strategy, our on-demand bookings and business, estimates of second quarter 2010 total revenues, recurring revenues, services revenues, perpetual license revenues, operating expenses, margins and profits, stock-based compensation and restructuring charges as well as sales and marketing expectations and strategies, product development and strategic partnerships and operating results in the second half of 2010.

Actual results may differ materially from any future performance suggested in our forward-looking statements. We refer you to the company's Form 10-K for the year 2009 on file with the SEC for important risk factors that could cause actual results to differ materially from those contained in any forward-looking statements. We expressly disclaim any obligation to update this forward-looking information.

On today's call, Leslie will begin with comments about our overall business and financial results. And then, I will discuss the financials in greater detail. We'll conclude with a question-and-answer session. With that said, I'll turn things over to Leslie.

Leslie Stretch

Thanks, Ron. Good afternoon, everyone. I'd like to begin today's conference call by briefly recapping Q1 2010. We opened the year with cautious optimism. Market conditions appeared to be improving steadily. We saw this in our business as we continue to be engaged in many opportunities, driving solid new and renewal business in the quarter.

Customers are still being cautious with their financial commitments, but we see improved appetite for our solutions. The impact of prior quarter's SaaS bookings continues to drive increase in the recurring revenues, delivering consecutive quarter growth. I'm also happy to report that our acquisition of ActekSoft has so far been performing favorable to expectations closing several good new business insurance deals in the quarter.

As expected, our license business was relatively small, given the focus on recurring deals. Our services revenue and margin were disappointing, as a number of projects that were anticipated to start in Q1 were pushed out to future quarters. We'll talk more about that later.

Let me talk about the following topics. Our Q1 performance, key products and marketing developments, our services business in more detail and our outlook on cost model and our timeline to profitability. Talking about Q1, sequentially revenues were up 5% over Q4 as our recurring revenue continues to grow. In the quarter, we won a number of competitive new business deals and at the same time, saw clients across industries and geographies increase commitments.

We believe the economy is moving in the right direction and our sales performance management proposition is well positioned to take advantage of future improvements. We executed a total of 15 transactions in the quarter, continuing our trend towards greater transaction volume in our legacy models. While at the same time, we continue to sign large enterprise deals.

We believe it's becoming increasingly clear to prospective customers that we deliver far and beyond the capabilities of any of our competitors and this has been a major factor in recent new business wins. In Q1, we had total quarterly revenues of $16.2 million, an increase of 38% year-over-year, reflecting the diminished significance of perpetual license and services in our software as a service business model.

Further supporting this shift, we saw our deferred revenue grow by over $5 million to its highest level ever of $27.3 million. It's notable that we signed several multi-year deals in the quarter. We signed a five-year mid-six-figure recurring revenue deal with a major North American cable business and we signed another three-year six-figure recurring revenue deal in the technology space.

At the volume end of the business, we signed several Monaco, Force.com and management by objectives during the quarter. On-Demand renewals were very strong with all companies due executing their renewals with Callidus and only one customer slightly reducing their spending with us due to an internal restructuring.

Whilst renewals will change from quarter-to-quarter, these results will test the underlying strength in the business. We booked over 3.5 million of services work, however, this was less than we expected as a number of customers who've already signed recurring revenue deals decided to push out the start of their services projects from the first quarter.

As I mentioned earlier, we've since seen momentum pick up, with a good amount of that delayed services business in the contracting process. Let me talk about key products and marketing developments. In the quarter, we continued to enhance our next-generation sales performance management's fleet, launching the spring 2010 release of Monaco.

The solution is designed to deliver more rapid times of value and ease of use for our customers. And our continued effort to drive down entry cost for our customers, we also delivered Monaco Propel, a fully featured on-demand sales performance management solution that can be deployed within six to eight weeks.

The new fast-track implementation option enables our customers to quickly recognize the value of our best in class sales tenant life cycle management suite and be up and running with industry leading best practices within weeks. Just last week, we also announced industry's first Pay-as-you-Go pricing option for our Monaco suite.

With the new option, customers can subscribe to our solution with dramatically reduced entry costs through monthly subscription. This enabled customers to bypass large scale and complex approval cycles, opening up the market to thousands of small-to-medium size businesses that require a more robust solution set for managing their sales and channel incentives and bonuses.

Early indications are that this strategy is being well received. In early April, we also announced the launch of our newest addition to the Monaco suite, sales coaching. With this new SaaS product powered by ForceLogix, Callidus now enables businesses to optimize their sales force effectiveness as part of the comprehensive sales force performance management solution. Under the agreement, Callidus has received exclusive rights, the only SPM vendor to sell ForceLogix SalesForce Optimizer solution.

After incentives, our customers are looking for additional ways to achieve higher returns on their sales investments, by driving even marginal gains in sales effectiveness through improved sales processes and coaching, businesses can drive significant gains and overall attainment in revenues.

By extending our suite to deliver improved selling effectiveness, Callidus has once again advanced in sales performance space and we are receiving a very enthusiastic response from customers, prospects and partners. This quarter, Callidus received a positive rating in the latest MarketScope for Sales Incentive Compensation Management Software by Gartner.

Last December, Callidus and ActekSoft were two of the only three companies that received the positive rating in Gartner's MarketScope for Insurance Incentive Compensation Management Applications. Let me now talk about our services business in more detail.

Over the past year, a number of companies have encountered significant challenges in their services businesses. We are no different. And while we believe we have some unique challenges, we also have some significant opportunities.

Our increasing on-demand business and improved ease of use and implementation built into the product have improved the customer experience, while at the same time negatively impacting our services revenues. At the same time, I believe we have significant opportunities to improve revenues and margin.

From a revenue point of view, we see opportunity to expand our recurring sales operation services business. On the margin side, our immediate focus is to improve the discipline of our utilization rates. With this in mind, we've appointed, Saeid Karamus [ph] as our new Senior Vice President of Worldwide Services. He comes to us most recently from Accenture, where as a respected partner he builds an impressive commissions practice. He is a seasoned executive, who has built substantial profitable businesses around Callidus including significant recurring sales operation services business. He is experienced in running effective services teams on and offshore and optimizing utilization.

He also enjoys an excellent reputation with our customer base. Saeid will take over from Merritt Alberti effective immediately. Merritt has been leading this group for the last year and will be helping the transition and then will be leaving Callidus to pursue other interests at end of May.

I'd like to thank Merritt for his work over the past few years and welcome Saeid to the company. Let me finish with some comments about Q2, our 2010 outlook on our cost model and the timeline to profitability. With regards to our outlook, it should be noted that after careful consideration, we will no longer provide information on net new ACV in our communications.

This metric was an important one over the past few years as it enabled us to show you how we were progressing in our transition from a legacy license business to a true recurring revenue company. While it may still be valuable over the longer-term, over the short-term, given the significant variability and recognition of deferral of revenues as well as its lumpiness over the shorter quarterly periods we report on.

We've found that ACV is frankly not a very good predictor of subsequent quarter's revenue. As the business evolves, we will continue to evaluate the most appropriate metrics to report to you. To answer the question the last time, this quarter, yes, we did have positive ACV and we grew our cumulative ACV. Going forward, we're going to focus on revenues and operating expense. In other words, we wish to adopt reporting standards of (inaudible) with other recurring revenue companies.

We believe that revenues for Q2 2010 will be up slightly again from Q1 2010. This reflects the growth in recurring revenues and we believe a stabilizing consulting business. Our revenue guidance for Q2 is $16.3 million to $17.3 million. We expect our operating expenses for Q2 will be between $10.6 million and $11.6 million on a GAAP basis, which includes approximately $2.3 million of restructuring and stock-based compensation expense.

We believe that we will attain operating profitability on a non-GAAP basis in the second half of 2010. We continue to drive revenue growth in our recurring revenue business and fine-tune our expense numbers.

In Q1, we took further actions to reduce our operating costs and particularly as it related to further leveraging our proven offshore capabilities. The full impact of these actions will be seen in Q2 operating costs.

In the second half of the year, we'll further benefit from the leases we recently signed to relocate our headquarters to Pleasanton, California. Now, I'll pass the call over to Ron to go over the financials in more detail.

Ron Fior

Thanks, Leslie. The first quarter presented some promising highlights in the continued growth and health of our SaaS business as well as disappointing results for our services business. Recurring revenues of $12.3 million were at a record level for the company and represented 76% of total revenues.

Deferred revenues also grew to a record high of $27.3 million, a $5.2 million increase over the prior quarter, reflecting the growth from new bookings as well as strong renewals for the quarter. Our retention rates for our core software-as-a-service offering as well as our legacy on-premises customers continue to be above 90%.

Our newly acquired ActekSoft business performed above our expectations. Unfortunately, our services revenues at $3.6 million were below our expectations as a number of our committed customers delayed the start of their implementation projects.

We continue to manage our expenses prudently. Despite increases resulting from the reset of FICO payroll tax of approximately $300,000 and higher audit and compliance cost associated with the acquisition, our non-GAAP operating expenses excluding the impact of ActekSoft were $9.4 million, consistent with the prior quarter.

Now, I'll walk you through the Q1 results in more detail. Unless I mention otherwise, the comparative percent increases or decreases are as compared to the same period of the prior year.

Let's look at total revenue. Total first quarter revenues were $16.2 million, down 38% from the prior year, primarily due to the change in our business model. The first quarter decline in license and services revenue as compared to the prior year was mostly expected and is reflective of our new business model. Our on-demand customers continue to benefit from faster and therefore less expensive implementation cycles compared with similar on-premises implementations.

It's important to remember that in an on-demand business, smaller but recurring ratable revenue streams are substituted for the majority of upfront license revenues. Further, the much shorter implementation times lead to less implementation revenues for us, but a quicker time to value for the customer.

By geography, 89% of first quarter revenue was generated in North America. This compares to 82% in the first quarter of 2009. Revenues continue to be diversified by verticals, which break down as follows. Insurance 27%, high-tech, manufacturing and pharma 36%, telecommunications 16%, banking 12% and retail and distribution 9%. These are all roughly comparable to Q4 levels.

Now, let's look at the recurring business. Recurring revenues represented 76% of our total revenues in the first quarter given the lower services and other revenues. We expect recurring revenues to continue to run at approximately 70% of revenues through 2010.

Recurring revenues for the quarter were $12.3 million, up 5% due to the growth in our on demand subscription revenue and our term license revenue, which together were actually up 13% compared to the same period last year. On a sequential basis, recurring revenues were up 5% reflecting an 11% increase in our on-demand subscription revenue and term licenses resulting from new bookings in the third and fourth quarter of last year.

Maintenance revenues are down slightly, both sequentially and on an year-on-year basis primarily due to the conversions of on-premises customers to our on-demand offering. Recurring revenue gross margin for the first quarter was 48%, down from 51% in the prior-year period and down from 52% in the prior quarter.

The decrease in margin from the prior period reflects an increase in third-party royalty costs related to both new and renewal on demand bookings combined with increased data center cost related to recent on-demand bookings. Due to the revenue recognition rules that require us to defer revenue on certain on demand contracts until the customer goes live, we often experience an increase in on demand infrastructure costs associated with the new customers that is not immediately offset by corresponding revenues.

Services business, services revenues for the quarter were $3.6 million, down 67% from the same period last year and 3% from Q4. The decrease in services revenues from prior year was expected as we transition to shorten – to shorter and less expensive on demand implementations.

The unexpected decrease from the prior quarter resulted as the number of customers signed in prior quarters delayed the start of their implementation projects to future quarters negatively impacting both revenues and gross margin. In the second half of the year, we expect moderate growth as certain projects go live.

Service gross margin for the first quarter was negative 21%, down from 17% in the prior year and down from negative 11% in the prior quarter. The decrease in services margin reflects lower than planned utilization resulting from the delayed projects and a decrease in our average billing rate. We have seen more competition in recent quarters from other system implementers utilizing more offshore consulting resources, driving down the average billing rate.

In Q1, we added our own offshore capability in this area. We expect the managerial changes mentioned earlier to help drive service revenues while improving our services margin in the coming quarters. Over the longer term, we expect to see margin improvement as we drive higher revenues and leverage less expense of third-party consulting resources. While we expect improvement in our services margin, we do not expect it to return to the level it was under our old perpetual license business model.

Perpetual license business. Our perpetual license revenues were 229,000 in the quarter down 92% from the prior-year period reflecting the shift in our business model. We closed another $500,000 of perpetual license business with terms that require us to differ recognition until the second half of the year. During the first quarter of the prior-year, we recorded $3 million in perpetual license revenue.

Let's talk about overall gross margin. Overall gross margin for Q1 was 32%, down from 41% in the prior year. The decrease in overall gross margin over the prior-year is primarily attributable to the $2.8 million decrease in higher margin perpetual license revenue over the same period as well as the negative services margin.

Operating expenses. We continue to manage our operating expenses aggressively. In Q1, overall operating expenses were $11.7 million, down 12% from the prior-year. On a non-GAAP basis, excluding the impact of restructuring charges totaling $719,000 stock based compensation of $1 million and amortization of acquired intangible assets of $157,000; operating expenses were $9.9 million.

This represents an increase of approximately $500,000 from the fourth quarter on a like-for-like basis. The increase in current quarter expenses reflects the addition of ActekSoft and approximately $300K of higher payroll taxes as a result of FICO reset that happens in the beginning of every year. Stock-based compensation by line item is disclosed as a footnote to the income statement included in our press release.

The restructuring expense resulted from headcount reduction efforts initiated during the quarter. Operating cost for Q1 incorporated only one month of savings related to the Q1 restructuring. The full impact will be realized in Q2, when operating costs are reduced again significantly.

Business model. From a business model point of view, we continue to see the impact of the growth in on-demand in the relative percentages of revenue. Recurring revenues accounted for 76% of total revenues in the quarter. At the same time, there was a 1% contribution from license revenue and the contribution from services decreased from 43% to 23%.

On the operating expense side, as a percent of total revenues, sales and marketing was 29%, R&D was 19% and G&A was 20%, all pretty consistent with the prior quarter. Income taxes. For the quarter, the company recorded a net tax benefit of $550,000, which is comprised primarily of the release of a portion of the company's valuation allowance in conjunction with the accounting for the acquisition of ActekSoft during the quarter.

Our total headcount at March 31, excluding contractors, was 285 employees, up two from the end of December. The net increase in headcount reflects the decrease in headcount related to Q1 restructuring activity offset by the addition of the headcount from the ActekSoft acquisition.

Balance sheet and cash flow. We finished the quarter with $30.2 million in cash and investments. This is a decrease of $4.5 million from December 31. The change in cash reflects the impact of our ActekSoft purchase and our cash operating loss, partially offset by solid accounts receivable collections and ESPP stock purchases.

Our net accounts receivable balance at March 31 was $15.6 million. Days sales outstanding for the quarter was 79 days, reflecting no change from Q4. Excluding the impact of changes in our deferred revenue, DSO would have been 73 days. Total deferred revenue including both short and long-term increased by $5.2 million to a record high of $27.3 million.

This increase is primarily related to the addition of new recurring revenue deals as well as renewals of existing recurring revenue and maintenance agreements. Pursuant to our acquisition of ActekSoft, we have recorded intangible assets totaling $1.5 million, related to customer relationships, develop technology, trade name and a favorable lease.

We've also recorded goodwill totaling $2.5 million. Total considerations transferred in the purchase of Actek including closing cash and stock, net realized working capital and contingent consideration is estimated to be $3.4 million based on the fair value as of the acquisition date.

Capital expenditures in the quarter were approximately $400,000. We continue to hold approximately $4.6 million in par value auction rate securities secured by student loans. We will continue to carry these auction rate securities until we are able to sell them.

At the time of sale, we will record a realized gain or loss from the sale. The auction rate securities held by one financial institution are classified as short-term due to the put option rates, which are exercisable beginning in June of 2010. We expect to exercise the put option as soon as it is exercisable.

The auction rate security without the put option remains classified as long-term due to the lack of liquidity. Now, let's turn to Q2. I want to remind you the Safe Harbor language provided at the beginning of the call. Further, it should be noted that we plan to update any guidance only during our quarterly conference calls.

As we have indicated, we're now focusing all our energies on recurring revenue streams, including a term-license offering for on-premises customers. At the same time, we expect to realize moderate levels of perpetual license revenues on a quarterly basis primarily from Latin America and Asia Pacific.

For Q2, we're expecting total revenues to be between $16.3 million and $17.3 million. This would represent a decline of approximately 27% on the low end of the range and a decrease of 23% on the high-end compared to the second quarter of 2009. It should be noted that this would represent a sequential increase over Q1 of between 1% and 7%.

Total revenue is made up of recurring revenues and services and other revenues. It is also important to note that in Q2 of 2009, total revenues included $1.2 million of perpetual licenses and $9.4 million of services revenues, which together represented 47% of total revenues in that period in a different stage of our SaaS evolution. Operating expenses are expected to be between $10.6 million and $11.6 million and include approximately $1.6 million of stock-based compensation and $0.7 million of restructuring charges.

Therefore on a non-GAAP basis, this would translate into a range of $8.3 million to $9.3 million, down significantly from 2009 and Q1. We remain committed to achieving profitability on a non-GAAP basis in the second half of this year. We have already begun executing on a number of our key operating objectives that are critical to this effort.

Firstly, during the quarter, we took action to reduce our operating expenses, so that we can further leverage our proven offshore resources. The full impact of these actions will be realized in Q2. Secondly, shortly after the year-end – after the end of the quarter, we executed the lease for our new Pleasanton headquarters, which will yield substantial savings in the latter part of this year.

Thirdly, we have a plan in place to address the health of our services business, which includes new executive leadership, a reduction in capacity that is commensurate with our current revenue expectations and additional sales incentives to drive additional service engagements. In addition to these items, we will continue to drive growth in our recurring revenue business and pursue further alignment of our cost structure where appropriate.

We will also continue to expect – to execute moderate levels of license revenue primarily from Latin America and Asia Pacific. During this quarter, we will be attending the TechAmerica Growth Conference, May 12 to 14 in San Francisco, the B. Riley Conference in Santa Monica, May 24 to 26 and the RBC Technology Conference, June 9 and 10 in New York. We hope to see you at one of those conferences.

I would now like to open the question-and-answer session. Operator, will you please prompt for questions.

Question-and-Answer Session

Operator

Yes, sir. (Operator Instructions) Your first question comes from the line of Michael Nemeroff from Wedbush. Please proceed, sir.

Michael Nemeroff – Wedbush

Hi guys. Good afternoon and thanks for taking my questions. Just from a high-level, Leslie, if you could just maybe walk us through where sales performance management products, how important they are at different times during the business cycle? For instance is this – do you think that sales performance management products will be an early cycle purchase or a mid-cycle play? I mean how long do we have to wait before you think that the business really starts to ramp?

Leslie Stretch

It's – well, it has definitely picked up. If we take certainly this Q1 versus Q1 a year ago, Q2 a year ago, no question. Q3 and Q4 last year, if you remember, was fairly strong for us. Q1, we expected a typical start of the year quarter but what we have seen on a number of key companies sign the major Canadian cable brand actually, where one of our competitors was already entrenched and we took it away a very significant value, multi-year value. We signed a few other multi-year deals. It was interesting – the multi-year deal structures were driven by customers as well who could see a lock-in and a rise in sales head count. So they are trying to somehow have a predictable cost going forward for key applications. And already in this quarter, we've signed a very significant big well-known household name Pay-as-you-Go telco brand that we're very proud to have as a customer.

We saw it was kind of shied away from naming our customers because some of the less fully employed itinerants are competitors tend to sit in on this call. So we kind of shied away from correct naming, but we literally just signed yesterday, a fabulous Pay-as-you-Go brand that you would know, it isn't very funny commercials on TV at the moment. And there are companies that, when I look at their momentum, their subscriber base moves in more positive times just like anybody else. And so I see those as leading indicators of what we should expect and I also say that we are involved in a very high number situations where we've already been selected and we just need to convert it to contracts. So that's my thought, I'm looking at it from our market point of view, but the sales performance management message is beginning to resonate very nicely for us. In certain segments, in certain verticals, it's absolutely mandatory, it's not a discretionary solution that they want to adopt, it's mandatory.

Michael Nemeroff – Wedbush

And then Leslie, I am sorry, Ron, you had mentioned in your prepared remarks that there were a number of customers that delayed their services implementations which would imply that the revenue, that some of it is still in deferred revenue. Could you tell us what the makeup of deferred revenue is product versus services? And do you expect, how much of that do you expect to generate in Q2 through Q4 on the services side, how much incremental should we be expecting?

Ron Fior

Okay. Well, so first off what happened is, there is roughly four customers, we closed one of those deals at the end of – so these were four customers who actually signed on-demand or recurring revenue deals in Q4 or even one in particular in Q3. And so, we anticipated them obviously getting their implementation up and running in Q1, which did not happen. We've signed – one of those were signed on at the end of Q1. And we have two others; two of the others are actually in the contracting process. So hopefully we will get those done. The fourth one is actually has – we'd like to get done this quarter, but they're having their own data problems and that's what's delaying their particular implementation. So we would expect that, we're not predicting any significant growth in the services revenues. We're predicting it to be stable but we do expect those deals to come in. And obviously that would take into effect, that will help out on the margin side in particular.

Michael Nemeroff – Wedbush

Okay. And just one last one, how many – what's the number of sales people that you currently have?

Leslie Stretch

Well, we tend to talk in terms of the whole group sales, marketing and actually – so it's not cohort [ph] in terms of the structure. We've got 40-ish sort of people in that group at the moment.

Michael Nemeroff – Wedbush

Okay. Thanks, guys. I'll pass along.

Ron Fior

Okay. Thank you.

Operator

Your next question comes from the line of Chad Bennett with Northland Securities. Please proceed.

Ian Calson – Northland Securities

Yes. Hi, guys this Ian Calson [ph] in for Chad today.

Ron Fior

Hi, Ian.

Ian Calson – Northland Securities

Just a few questions here. On the ACV numbers, are you not going to give any more, I know you'd said that last quarter, you're not going to give bookings off and either. So I guess, I'm wondering how you're going to sort of give us an idea of how the business is performing here going forward and are you going to go back to bookings or what are you thinking at this point?

Leslie Stretch

I don't think we're – one of the reasons we went to this business model was to deliver for our investors of a perspective of a growing recurring revenue business and we've said we were profitable in the back end of the year. So we want a profitable growing recurring revenue business and that pays back to our customers in the long term is to do more. So we really want to get into the business model and the reporting framework of the other SaaS and recurring revenue and that we see a mixture of different metrics, when we see people taking revenue plus change in deferred and reporting that. A fairly big company or a fairly big SaaS company just reported yesterday and that's precisely the metric they used.

We're also seeing deal profiles change, so now we're up to 80 or so customers in the on-demand space. It's a different world, when we were doing our first few customers we had to prove that the solution was effective and good to use and we have to get renewals. We've now got customers renewing for an additional, they've been on board for two or three years, renewing for three years. We've also got new customers looking to optimize their financials and commit to two or three years. And actually it's quite good for us and I know just that in other SaaS companies, they report this as I say, revenue plus change in deferred and is often deferred, is often a function of the deals that they signed in the quarter. And if they are multi-year deals, particularly if in some cases there is a cash in bonds, (inaudible) deferred revenue. So, it'd be wrong to probably give you we haven't set out to talk about that in any detail. It would be wrong to probably give you a flavor for what that would be if we looked at it from that perspective.

Ron Fior

And so we actually didn't check it out and if you took a look at our recurring revenue plus the change in deferred and compared it to last year Q1, we were up 33%. It sounds really good. I'm not sure that it tells you very good things about that we are doing things in our business, but it's not a very good predictor and that was of the next quarter's revenue and that was the issue with the ACV. I mean we have almost $1 million worth of ACV that's sitting there, that's going to come in over the next quarters that will – as we go live on different projects and when you did it previously, we did it, everybody would assume, okay, 25% is coming in, in the next quarter. And that's been unfortunately not a good predictor of what's been actually happening. So that's really what it comes down to. We're doing good business. And...

Leslie Stretch

We also – I forgot to mention we also have – we've found an appetite at least at the tail-end of this transition in the economy for certain customers to look for short-term commitments and pay-as-you-go and even prepared to pay a premium or pay-as-you-go structures, where they don't have to go and acquire these big budgeters and it's something our competitors simply haven't got the courage to do. They just cannot do it. Couple that with ease of use, best products in the market and we've got a market there and so before we couldn't have respond to that, now we can. So, different deal structures different profiles. We want to be able to have flexibility there but also we do want to adopt the standards of the other recurring revenue companies.

Ian Calson – Northland Securities

Okay. Can you give us an idea of what attrition was in the quarter at least directionally versus Q4 –?

Leslie Stretch

Yes, we did mention. We did mention that we renewed every customer. And one customer had a small reduction because they are restructuring. I don't want to name the customer, because they had had a prior Chapter 11 event. But we retained them through that and indeed, we actually moved the whole number of payees to the new owner of the assets and in that transaction we had a small reduction. So nothing like what we experienced in the first half of 2009.

Ron Fior

No. And we will continue to talk about retention and maintenance in both the on-demand and the maintenance side and we actually stated in our – in the script that it was over 90% renewals in total. But the actual, as Leslie said, even in the on-demand, every single customer renewed for at the same level or greater with the exception of one and that's a pretty solid result in my books.

Ian Calson – Northland Securities

Yes. Okay, all right. And subscription gross margins here, a little bit obviously a little lower here than we were thinking. Are the impacts on this quarter, how do we think about that next quarter and the rest of the year here? Is that is this going to be a continual impact from those two issues? I think it was the royalties and...?

Ron Fior

Yes. So we were – we ended up having a situation where we've actually consumed more than we anticipated at this particular third-party product. And unfortunately given the way that the contract was set up, it's become somewhat punitive for our smaller customers and for customers that have AC have recurring revenues of 100 grand or less. And unfortunately because of that mix in this particular quarter and probably in Q2, it will have a similar impact but we hope to have that renegotiated and straightened out going forward. So that it can drop back to a more normal level.

Ian Calson – Northland Securities

Okay. So do you think that the subscription gross margin you can grow here for the full-year?

Ron Fior

Absolutely. For the full-year?

Ian Calson – Northland Securities

Yes.

Ron Fior

Absolutely. I mean it had a negative impact and one of the guys here can correct me if I'm wrong, I think it was almost five percentage points in this particular quarter and compared to what we were anticipating.

Ian Calson – Northland Securities

Okay, all right. On to service gross margins then, is best-case scenario breakeven here going forward at the gross margin level?

Ron Fior

I think that we should be at breakeven, you have to remember that. So we had a loss of roughly $500,000 in the quarter. $500,000 is roughly equal to seven services employees employed for the full quarter. If we had closed these four deals that we were supposed to close they would have been fully occupied and then sum and you would get back to more of a – obviously a profitable scenario. So that is definitely our goal and we've had the management change, we've got incentives to drive more sales of services revenue and in particular the services operations side of the business. So we're trying to make every effort to at least (inaudible), but definitely to get back to break even in Q2 and then profitable in the second half of this year.

Ian Calson – Northland Securities

Okay.

Ron Fior

Leslie, you want to add to that?

Leslie Stretch

Yes, I think we've had a run here of businesses that has had some difficulties because of timing of deals, and as Ron mentioned the tolerances are pretty fine to find people not billing and then subsequent to that end of the quarter, customer signs the statement of work to do the project. It has a big impact and I think what you were asking the new management to immediately establish, confirmed growing profitable services business. It will never be like the old business, which was all perpetual license, big heavy weight implementations, but it ought to be healthier than it currently is and that's the one area that we need to really focus on. And we put a lot of investment in thinking that through and getting the right leadership in place as I mentioned in the script.

Ian Calson – Northland Securities

Okay. And real quickly on the OpEx guidance, I mean you guided down here, the restructuring is a large chunk of that, I take it. What do you have to do to get down at the low end of that range? Are you there with the restructuring or – give us some color on that side if you can?

Ron Fior

Yes. So you're going to see a significant drop in this particular quarter. And then when the, in Q3 and in Q4 in particular, you will also see additional drops with the impact of the Pleasanton move. That really will only impact us maybe one month out of Q3 and then it's full impact with the flow through in the next quarter. We're well along the way. There is going to be a significant change in the operating cost this quarter.

Ian Calson – Northland Securities

Okay and then my last question, I'll let somebody else get to it, if you can just update us on the force.com side and how things are going there quickly I'd appreciate it? Thanks.

Leslie Stretch

Yes, we've got a dozen or so customers now, some quite significant ones and in the pipeline actually some quite big ones complying [ph] communication in particular. We have Salesforce themselves as a customer now, I believe, live with the complying [ph] communicator, so nice progress.

Ian Calson – Northland Securities

Great. Thanks.

Operator

Your next question comes from the line of Kevin Liu with B. Riley & Company. Please proceed.

Kevin Liu – B. Riley & Company

Hi. Good afternoon guys. I guess just one follow-up on the professional services gross margin. Should we take it to mean that in the near-term it sounds like you guys will get back to break even or better on revenue growth from that area as opposed to headcount reductions?

Leslie Stretch

I think we've tossed fairly. The person that we're bringing in has built very large businesses around Callidus and commissions environments. From an implementation perspective, but more critically looking forward from us, from a point of view of running sales operation services contracts and lot of our larger customers want a some degree of, I hesitate to say outsourcing, but they want some degree of management of the business process. And we do that actually very well for a few large customers at the moment. We have outcomes-based contracts. So I see that was from a cost and OpEx basis, there is a kind of a net neutral effect of changes. I actually see that as an investment and we intend to invest and focus on that. We get that piece of the business into the sort of confirmed profitable and growth part that the recurring revenue is in and I think that puts us in better shape. There's certainly demand out there. We have had a lot of, we have had some top price services, competitors and also some companies that used heavily, that use off shoring components in their project business and we've started to do that as well. We now have an ability to access a fair number of skilled, very skilled people in the lower cost environment and that should accelerate some implementations on. But we do have a fairly active pipeline of consulting bookings and we have the one that we didn't close in Q1 and they are confirmed customers. So we're going to get them – we're going to get the services business.

Kevin Liu – B. Riley & Company

Got it. And then given all the changes that are going on the expense side right now, once you guys are realizing the full benefits of all the restructuring efforts and there's also headquarters move. I mean, what level of revenues would you need in order to be profitable as you move out of 2010?

Leslie Stretch

I would say, it's roughly $18 million in total.

Kevin Liu – B. Riley & Company

And then, with kind of the 40-ish quota-carrying heads right now, obviously you guys aren't giving kind of ACV targets or anything like that. But I just want to get a sense, does that alter kind of the $3 million to $5 million in ACV that you guys had originally kind of targeted it from – in any one particular quarter?

Leslie Stretch

Well, let me make a couple of points. Kevin, we said we have 40 people in the sales and marketing group. So we don't have 40 quota-carrying heads. Bulk of the group are quota-carrying heads. Secondly, ACV, pure ACV bookings value and your bookings value of a deal is the way the compensation regime works for our sales people and that's absolutely the right way to do it. So that is a huge internal measure and we pay people on that. It's very important, but it's the way that it reconciles with revenue and the way that we see other recurring revenue companies focus on growing revenues and OpEx and the bottom line, that's where we want to be. So it's not that we, from a sales perspective, absolutely, they are totally under the gun to perform to ACV. In terms of backing away from what we said, I don't want to get – I don't have to go backwards now, so that what we were using as a transitionary measure to help people understand how we were going from the old model to the new. We want to – our targets and assumptions should produce the growing and profitable recurring revenue business that we projected.

Kevin Liu – B. Riley & Company

All right. And just one last question. You mentioned that you had a few maintenance paying customers who moved to the on-demand model. I'm just wondering how many of those there were in the quarter and kind of who initiated those discussions, whether it was from you or your customers?

Leslie Stretch

Actually, we didn't in Q1. We didn't do any conversions. And of the almost 80 on-demand customers only 20 are conversions and that's been a fairly – we've been focused essentially on new business, the new on-demand business. And as customers hit an upgrade cycle for infrastructure, that's when we look at helping them to make a more cost-effective move to on-demand. So I think we didn't do conversions in Q1. I expect we'll do a few in Q2 and through the rest of the year but it's more of a steady stream because most of the quota-bearing effort is focused on winning new main [ph] business.

Kevin Liu – B. Riley & Company

Okay. Thanks.

Leslie Stretch

Thank you.

Operator

Your next question is a follow-up from Michael Nemeroff with Wedbush. Please proceed, sir.

Michael Nemeroff – Wedbush

Hey, guys. Just the breakdown of the $12.3 million subscription and support revenue. How much of that is on-demand subscription versus legacy maintenance type revenue?

Ron Fior

The maintenance number is $5 million roughly.

Michael Nemeroff – Wedbush

$5 million?

Ron Fior

Yes.

Michael Nemeroff – Wedbush

Okay. So as I see it, you're doing – as things stabilize, it looks like you're going to do between plus $500K and plus $600K a quarter on that subscription and support revenue. And by Q4, that growth rate year-over-year, as you start to anniversary the complete switch, I mean, you should get into the 15% to 20% growth range on subscription and support revenue. Am I thinking about that correctly?

Ron Fior

Yes.

Michael Nemeroff – Wedbush

Okay.

Leslie Stretch

I mean, there are some – also and this goes back to the ACV discussion. There will be some good deferrals coming through in the future and also at the top end overall revenues, we get – that's when we get into more favorable comparators, you know, Q3 you tend to see it clearly, but Q4, it is crystal clear for us.

Michael Nemeroff – Wedbush

Right. And so even if the services and the other revenue stays flat or does relatively nothing for the year, you're going to exit the year based on the run rate that you're going with somewhere in the neighborhood of 15% to 20% total revenue growth over Q4. Is that – does that sound correct?

Ron Fior

In Q4?

Michael Nemeroff – Wedbush

Yes.

Ron Fior

You're in the ballpark.

Leslie Stretch

Yes, you're in the zone.

Ron Fior

Yes. That's how we are thinking of it.

Michael Nemeroff – Wedbush

Okay. And then so for the year, Ron, if you wouldn't mind just some of the CapEx expectations for the rest of the year as well as where you're thinking in terms of cash flow from ops positive for the year? You guys have an unusual cash flow from ops seasonal pattern whereas most software companies book in Q4 and collect big in Q1. Your Q2 tends to be your bigger quarter of the year. Could you explain that one?

Ron Fior

I can't explain it per se but I would tell you that, we – if you remember back to last call, we thought, we would use about $6 million this quarter and then we were actually favorable compared to that. And so – but we do expect to use maybe another $2 million and that should probably be the low point, we believe.

Michael Nemeroff – Wedbush

In Q2 or for the year?

Ron Fior

In Q2. Yes, we expect to use another $2 million in Q2 and then hopefully that will be – from that point on move into the positive range, going forward.

Michael Nemeroff – Wedbush

Okay. Great. Thanks very much for the follow-up questions. Thanks.

Ron Fior

Okay. Thanks.

Operator

Your next question comes from the line of Ted Ketterer [ph] with TK Associates. Please proceed.

Ted Ketterer – TK Associates

Hey, guys. I got a couple of questions. Leslie, did I just hear you say that Salesforce is a customer?

Leslie Stretch

Yes, you did.

Ted Ketterer – TK Associates

Congratulations.

Leslie Stretch

Thanks.

Ted Ketterer – TK Associates

Could you explain this ActekSoft acquisition and how they fit in because the press release didn't? Well, maybe I didn't understand it, but could you go in more into that what they brought you and why you are doing?

Leslie Stretch

Yes, sure. So, they have a product that fits very well in the – I would call it, the mid-tier healthcare insurance space. You have some general insurers. It's very much oriented towards that – a certain rank of insurance business with certain payee accounts and certain complexity. And they brought with them 30 customers and we've retained them all and they are great customers. They brought with them a beautifully crafted product that fits that space perfectly. It's unbeatable in my opinion. They brought with them some nice revenue. They had $4 million or so revenue last year. And in Q1 they brought with them immediately two brilliant new business deals. And I don't want to name customers too much because we look on our webcast list here and we see a bunch of competitors a bit idle, certainly listening, but in this case, it's already done. And they brought us Americo and a nice, very nice deal in the first month after the acquisition, a great customer to have implementation underway. And then, they brought us Securian at the end of the quarter, a new business deal and they have a nice consistent pipeline, couple of deals a quarter and actually in their space (inaudible) and their customers are almost 100% informally referenceable.

Ted Ketterer – TK Associates

Okay. Great.

Leslie Stretch

Okay. Thank you.

Ted Ketterer – TK Associates

So, are we just sitting here saying, this baby is about to come but it's just – it's going to be a little later?

Leslie Stretch

No. We are sticking to what we said. We said three-year transitions start of this. We're now in Q2 of the third year. The transition I believe, that people need to see year-over-year, a good year-over-year comparator. They began to see that towards the back end of the year and they need to see nice free cash flow profitability and that's where all of our efforts are focused on. The one area that we struggled a bit with is the services area and I think, we just – spin a massive skill sets and approach. And our ambition is for that not to go down, is for it to get a little bit of growth, a lift under it and to make some profit. But we also still want a lot of partners to implement our solution. We, our competitors put out some amongst all the horrendous stories they throw at the market leader. They put out stories that we do all ourselves and actually 70% plus of our implementations are conducted by third parties.

But there is still enough room in that 30% for us to have a nice profitable business. And also, there is enough room for us to have some sales operation services business with some of our key customers. We do that already with some of the big pharma companies and we would like to extend that into the telco space and into the finance space as well.

Ted Ketterer – TK Associates

The person from Accenture that just came on board, because I'm thinking that I was at one of the user conferences and I saw an Accenture package where they put together Salesforce and a search engine and you guys.

Leslie Stretch

Yes.

Ted Ketterer – TK Associates

Is that the same? Are they going to – is this person responsible for building those unique applications?

Leslie Stretch

He is an individual who built up both a consulting practice onshore and offshore. And he also built up a sales operation services practice for the business. And so he was basically focused on solving the end-to-end, an insurance based on-boarding and commissioning problems for customers. We are not going into the Accenture space. He just happens to have been a partner from Accenture and we are involved in a number of key engagements with Accenture at the moment. But he does bring a unique capability that we haven't had before at that level.

Ted Ketterer – TK Associates

Is there any change you could give a range of the revenue base that he built?

Leslie Stretch

He built businesses from 0 to $60 million to $70 million.

Ted Ketterer – TK Associates

Yes.

Leslie Stretch

So he – laterally, he was running a $70 million business. He put more than 70 people in an offshore implementation center, making the cost model much more effective, he pioneered it.

Ted Ketterer – TK Associates

So this guy was running the $70 million operations out at Accenture and he came to with Callidus?

Leslie Stretch

That's right.

Ted Ketterer – TK Associates

Okay, great. Thanks guys.

Ron Fior

Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Gregg Speicher with Moss Creek. Please proceed.

Gregg Speicher – Moss Creek Capital

Hey, guys. So as you said Leslie, you said it's picking up. Are you seeing any verticals in particularly jump into the pipeline more rapidly than others?

Leslie Stretch

We've been – yes, we've been selected in three insurance companies around the world at the moment and we are in the contract space. We've – as I mentioned, we signed a fabulous well-known brand Pay-as-you-Go mobile company with some really exciting commercials at the moment on TV, great company, head to head competitive. Oracle, one or two of the smaller itinerants, but Oracle principally and so we see telco and insurance, nicely picking up as always and we've got some good action in pharma and we've got some high-tech action as well. So there's always verticals we're seeing. And we're seeing it in the way clients are adding to sales heads and payee accounts as well.

Gregg Speicher – Moss Creek Capital

Okay. So it sounds like it's very diversified then?

Leslie Stretch

Yes. Well, we still have this very strong. We've got 70 plus insurance customers and approaching 50 telco customers now. And so those verticals are real strong and obviously, pharma – pharmas are smaller in market in terms of numbers, but payee accounts is pretty big and it's big in revenue because we do a lot of complex upstream processing there. So those three markets are pretty good, but we've got other – we held a webinar last week and we had real diversity of customers and prospects and there we had people like Caterpillar on that and so on.

Gregg Speicher – Moss Creek Capital

Okay. Great. Ron, on a pro forma basis, you said the cost of recurring revenues is up about $1 million, how much of that was extra data center cost versus the – were the third party cost that you were talking about? I want to make sure I understand that million jump.

Ron Fior

Yes, a big chunk of it was third-party costs.

Gregg Speicher – Moss Creek Capital

Okay. That was the most of it; it wasn't a big data center expenditure to get things…

Ron Fior

No, no actually no. We are looking at expanding our data center as we need it. However, actually when we do that, we're probably going to have some efficiencies that actually they're going to start showing up because everything seems to be getting cheaper these days.

Gregg Speicher – Moss Creek Capital

Now that's good, okay. Leslie, last question. So maybe do you have like an average contract length available and just starting to get longer…?

Ron Fior

Not an exact, but on average it's probably between say 1.25 to may be 1.5 years.

Gregg Speicher – Moss Creek Capital

Okay. Great.

Ron Fior

Yes.

Gregg Speicher – Moss Creek Capital

Right. That's it for me. Thanks a lot.

Ron Fior

Thank you.

Operator

Your next question comes from the line of Bill Swanson with Northland Securities. Please proceed.

Bill Swanson – Northland Securities

Hey, guys. Sorry, I got on the call late and missed a good chunk of it. Somebody may have already asked this. So I was just wondering if you could give out the – I don't see it in the press release, your gross and net ACV for the quarter?

Leslie Stretch

We had a long discussion about that on the script. And we've had a number of questions already. I think the best route is for us to go through, after the call go through the transcript with you. Basically, what we are trying to do is to move the business reporting to be in line with other SaaS companies. And we talked a little bit about revenues, plus change in deferred which is very significant in the quarter. But we moved away from giving pure net ACV because it doesn't serve as a useful measure for short-term forecasts. It's one of the reasons the other SaaS companies don't give it. We're focusing on revenue and operating expense. And occasionally, we'll talk about revenue, plus change in deferred. Change in deferred is a good proxy for the strength of the business.

We did better, it was positive. We did better than this time a year ago significantly. But the real focus is revenue, how that trends, operating expenses, how that trends and as I say, occasionally we'll talk about the revenue and plus the change in deferred. And you may have missed it but, Ron commented that we had a significant change in deferred of over $5 million in the quarter. And we are at a record high in deferred now at $27.3 million.

Ron Fior

Yes. And for the – some – I think somebody had asked the mix on that and I just got that available, it was roughly one-third maintenance and roughly two-thirds recurring. There's a little bit of services and license in here, but it's mostly on the recurring side, that's not deferred revenues.

Bill Swanson – Northland Securities

And that's a third of the $5 million (inaudible)?

Ron Fior

A third of the total deferred revenue.

Bill Swanson – Northland Securities

Total deferred. How about the $5 million?

Ron Fior

Actually most of that is and again, most of it, probably two-thirds of it – if not most of it is in – there's hardly any change in the other lines, so it's mostly the recurring.

Bill Swanson – Northland Securities

Okay. If – how – I mean we went from a period where we were getting ACV. I mean we are just coming off a quarter here where we kind of missed guidance here. So, looking for something just to kind of hang our hat on here. I mean how did you feel overall that you had some issues on the service side, so did the bookings come through? I mean are you happy with what you booked in the quarter or did you have some push-outs there as well?

Leslie Stretch

Well, we gave guidance for Q2 and actually one of the previous callers gave a fairly – it was fairly accurate and firm view of the outline causes. And the whole call we went through the rationale for that. And we want and I believe our investors want us to behave like the other recurring revenue in SaaS companies and they don't deal with that measure, right. So we're not going to do it. We are moving ahead like the other – this is why we spend all this time and effort to get into the model, so that we can talk about the growing revenues, the operating expense, the improving bottom line and ultimately the free cash flow.

Bill Swanson – Northland Securities

Okay. Thank you.

Ted Ketterer – TK Associates

And your next question is a follow-up from Ted Ketterer with TK Associates. Please proceed.

Ted Ketterer – TK Associates

Leslie?

Leslie Stretch

Yes.

Ron Fior

Yes. Hi.

Ted Ketterer – TK Associates

I want to be very candid. You just said the investors want you to act like other SaaS companies. And I would tell you this investor wants the stock to go up. And if it means continuing with ACV until you get to the numbers in the end of the year, I strongly suggest you might think about continuing with ACV. Okay. End of the summit [ph].

Leslie Stretch

Thanks.

Operator

There are no more questions in queue. I would now like to turn the call back over for closing remarks.

Leslie Stretch

Thanks everyone for taking the time with us on the call today. We look forward to speaking with you again next quarter.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Callidus Software Inc. Q1 2010 Earnings Call Transcript
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