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Concur Technologies (NASDAQ:CNQR)

Q2 2010 Earnings Call

May 03, 2010 5:00 pm ET

Executives

John Torrey - EVP of Corporate

John Adair - Chief Financial Officer and Principal Accounting Officer

S. Singh - Chairman and Chief Executive Officer

Analysts

Sid Parakh - McAdams Wright Ragen, Inc.

Laura Lederman - William Blair & Company L.L.C.

Thomas Ernst - Deutsche Bank AG

Steven Ashley - Robert W. Baird & Co. Incorporated

Ross MacMillan - Jefferies & Company, Inc.

Mark Murphy - First Albany

Karl Keirstead - Kaufman Bros.

Stephanie Withers - Goldman Sachs Group, Inc.

Robert Breza - RBC Capital Markets Corporation

Operator

Good afternoon. My name is Anyeta, and I will be your conference operator today. At this time, I would like to welcome everyone to the Concur Q2 FY'10 Earnings Release Conference Call. [Operator Instructions] I would now like to turn the call over to John Torrey, Executive Vice President of Corporate Development. Sir, you may begin your conference.

John Torrey

Thank you, operator. Good afternoon and welcome, everyone to the Concur Earnings Conference Call for our Second Quarter of Fiscal 2010. My name is John Torrey, Executive Vice President for Corporate Development for Concur. This call includes presentation slides that will accompany our prepared remarks. To access these slides, please log on to our website at www.concur.com. Other information of interest to investors, including our SEC filings, press releases and recent investor presentations can be found on the Investor Relations page of our website. We are now on Slide 1. Our speakers for the call today are Steve Singh, our Chairman and Chief Executive Officer; and John Adair, our Chief Financial Officer. After their prepared statements today, Steve and John will host a brief question-and-answer session.

Please now advance to Slide 2. Before we get started, we want to remind you that during the course of this conference call, we will discuss our business outlook and make other forward-looking statements regarding our current expectations of future events and the future financial performance of the company. These forward-looking statements are based on information available to us, as of today's date and are subject to risks and uncertainty. We encourage you to review the details on the Slide 2 and our filings with the Securities and Exchange Commission, which are available at www.sec.gov, for additional information on risk factors that could cause actual results to differ materially from our current expectations and the forward-looking statements expressed or implied during this conference call. We assume no duty or obligation to update these forward-looking statements, even though our situation may change in future.

Please now advance to Slide 3. At this time, I'd like to turn the call over to Steve Singh. Steve?

S. Singh

Thank you, John, and good afternoon, everyone. Two of the top five themes to take away from the call today. First, fiscal Q2 performance against key metrics, such as revenue, earnings and free cash flow was well ahead of our expectations. Second, the year-over-year growth rates for Q1 and Q2 were ahead of our expectations. We expect Q3 and Q4 growth rates to be higher, as compared to Q1 and Q2, but consistent with the expectations we outlined at the start of the fiscal year. Third, we see several long-term growth opportunities for our business, including growing our customer base in the markets we currently serve, geographic expansion, addressing the emerging business sector and expanding the range of services that we deliver to our customers. And as such, we are investing aggressively across the business. These investments include any incremental margin that may be realized throughout the course of the year from our performance against our original expectations. Fourth, we issued a convertible senior note, raising $287.5 million in cash. We expect to put that money to work during fiscal 2010 and 2011, as we look to drive more compelling value for our customers and their travel suppliers.

And fifth, I'm pleased to announce the appointment of Frank Pelzer to the role of Chief Financial Officer. Frank and I have worked together for nearly a decade and his expertise in corporate finance, M&A, as well as his depth of knowledge of the technology industry will be a significant asset our business over the next decade. I'm also pleased to announce the appointment of Mike Koetting to the role of Executive Vice President of Supplier Management and Advertising. Mike's background as COO Carlson Wagonlit North America and his 17 past years of experience in the corporate travel industry will be a significant asset our business, as we expand the range of services we can deliver to our customers and their suppliers. Please turn to the next page.

Turning our attention to Q2 results, we saw exceptional operating performance across the business. Revenue reached an all-time high at $72.8 million, driven by 8% quarter-over-quarter growth in revenue. This growth was driven in part by faster than expected deployments of new customers and in part, by stronger-than-expected transactional volume. We are very pleased with the 17% year-over-year growth in revenue for Q2, especially in light of the strong growth we saw in the year-ago quarter.

Strong revenue growth led to non-GAAP EPS for the quarter of $0.31 per share, which was $0.03 a share ahead of our expectations. However, as I stated earlier, you should expect us to invest that incremental margin during the remainder of this fiscal year. And, driven by stronger earnings and strong cash collections, free cash flow on the quarter was $14.2 million, also well ahead of our expectations. Please turn to the next slide.

We're obviously very pleased with the performance of our business in the first half of the fiscal year. And it's comforting to see stability in a broader economic environment. In thinking about expectations for the remainder of the fiscal year and fiscal 2011, it's helpful to understand the growth drivers of our business. Our growth is driven by three core factors. First and foremost, our growth is driven by new customer additions and new services we can deliver to our existing customers. We continue to see solid momentum in terms of new customer growth and cross-selling of new services to our existing customers.

The second factor to look at is the employment environment. Unemployment, while still hovering around 10%, remain relatively stable throughout the quarter. It's pragmatic to assume that in the near term, any economic recovery will be a jobless recovery and that while unemployment may drift down, it will remain relatively high for the next few years. Analysis that we have seen around when unemployment might return to pre-recession levels points to 2015.

The third variable is the travel environment. Travel transactions in Q2 were ahead of our expectations and are clearly trending back towards the waterline. However, it's important to note that we are still well below pre-recession levels. Based on recovery periods from prior recessions, it will likely take until late 2011 before travel spend fully recovers to pre-recession levels. Please turn to the next slide.

Given the strong performance of our business in Q1 and in Q2, and the relative stability of the macro environment, it may be tempting to get overly optimistic looking at the second half for the fiscal year. I want to interject a little caution here. While it is our expectation that Q3 and Q4 year-over-year growth rates will be stronger than what we saw on the first half of the fiscal year, we expect those growth rates to be very much in line with the expectations that we outlined at the start of this fiscal year. So halfway through our fiscal year, it's clear that we can achieve our revenue and earnings targets for the year as a whole, just as we outlined at the start of the fiscal year. And, given the strength of our business in Q1 and Q2, we expect cash flow from operations and free cash flow to be higher than originally expected. Please turn to the next slide.

Over the past several years, our views on the market opportunity and customer requirements to date have been wholly validated. And therefore, we're in a unique leadership position to expand the market from our foundation. As we look ahead to the next several years, we see substance of growth opportunities for our business. Those growth opportunities are in the following areas: Expansion of our customer base in the markets we currently serve; geographic expansion into new markets; serving the needs of the emerging businesses; and expanding the breadth of services that we can offer to our customers and their suppliers. Consistent with our commentary on the last several earnings calls, we have and will continue to significantly increase our investments across the business against these opportunities. Please turn to the next slide.

In support of the first growth initiative, which is to expand our base of customers in the markets we currently serve, we continue to expand our internal distribution capacity and our investments and market development. As a result, we saw strong new customer growth in Q2 and expect the demand environment for our services to remain strong throughout the fiscal year. Our relationship with American Express continues to drive value for both of our companies and more importantly, for our customers. Q2 was the strongest quarter since the inception of the partnership, in terms of new customer bookings and pipeline growth. Please turn to the next slide.

In support of the second growth initiative, which is geographic expansion into new markets, we continue to expand our internal distribution capacity, our investments in market development and our local product development capacity across Europe. In Q2, we entered into a strategic partnership with Amadeus, the leading GDS in Europe. We described the details of that partnership in the last earnings call. I'm pleased to report that we have completed the integration of Amadeus' core distribution technology into Concur travel. We expect this partnership to drive new customer growth towards the end of this fiscal year or the early part of fiscal 2011. We also see significant opportunity in China, India, Japan, Australia, Southeast Asia and Brazil. The investments we have and will continue to make against these opportunities are very long-term in nature, and are not expected to appreciably contribute to new customer growth until 2011 or to revenue until 2013. And just as we did in the case of Etap-On-Line, we may augment our organic growth opportunities and investments with targeted M&A for strategic partnerships, if and when those opportunities arise. Please turn to the next slide.

In support of our third growth initiative, we are also investing to deliver Employee Spend Management services for emerging businesses on a global basis. We define an emerging business as companies that employ between one to 250 employees. Nearly a third of the U.S. workforce is employed by emerging businesses, and nearly 40% of the global workforce is employed by emerging businesses. We believe that this market segment is underserved and can generate incremental, long-term revenue and earnings growth. In early March, we launched Concur Breeze through both our own distribution channels and in partnership with Google. Within the first few weeks, we've seen several hundred customers sign up for Concur Breeze trials. And while we expect to see significant traction for Concur Breeze in the second half of the fiscal year, we don't expect that it'd contribute meaningfully to revenue in fiscal 2010. Please turn to the next slide.

Finally, we continue to invest aggressively in innovation, expanding the range of services that we can offer our customers. Those investments in innovation include three major categories, Mobile services, Web services and SAS 2.0. Last year, we introduced Concur Mobile for Blackberry, for Windows Mobile and for iPhone platforms. As reminder, Concur Mobile extends the power of our service by giving you the capacity to change flights, book taxis, hotels or dining, capture expenses and approve expense reports, all from your handheld device, all within policy, and all while on the road.

Smartphones extend the benefits of cloud computing to an ever expanding range of users, that will access a wide range of cloud services on anytime-anywhere basis. For the purpose of the buying market, smartphones are for all practical purposes, becoming purchasing and payment instruments. We see a tremendous opportunity to deliver value to our customers by integrating a wide range of mobile applications into our technology platform. Over the long term, Mobile platforms and applications will provide for new and incremental revenue and earnings growth opportunities. In support of our Concur Travel & Expense service, we've invested to build up our Global Concur Connect network, which connects our 10,000-plus customers, who spend more than $35 billion annually to content and electronic receipts from hundreds of suppliers, that are focused on reducing their own operating costs and providing more value to the business traveler.

Over the past year, we ramped our investments to deliver Web services that will expand the Concur Connect Network into a platform that allows our customers and our partners to deliver content and electronic receipts or build web-based or mobile applications that extend and enhance the value of our services.

10 years ago, as John and I went from an investor meetings to investor meeting, we talked about how on-demand computing or SAS was the next generation of software. How the cost, delivery and maintenance benefits of this type of business model were so compelling that all software would move to this business model over the next few decades. Understandably, there were some debate about the concept back then. There's no debate today. In fact, the new debate will be around SAS 2.0. As more and more companies outsource business processes that are not mission-critical and not central to the value they deliver to their customer, they're looking to outsource all elements of that business process.

In the area of Travel & Expense Management, the majority of those business processes can be automated via technology and delivered in an on-demand model. Earlier this year, we released the first version of Concur Advantage services. A wide range of offerings that allows our customers to get greater value from our core suite of services. Examples include customized report authoring, expense report auditing, VAT recovery and digital mailroom services for invoice and receipt handling. In the coming quarters, we'll add new services, such as automatic fraud detection. We have seen strong customer adoption of Concur Advantage services in the first half of fiscal 2010. Please turn to the next slide.

The strength of our core business not only affords us the opportunity to deliver compelling revenue, earnings and free cash flow growth in fiscal 2010. It affords us the opportunity to invest in the growth initiatives I've just outlined, that enable incremental revenue and earnings growth opportunities in the years ahead. As you know, we believe there's an incredible opportunity to drive innovation and efficiency into the corporate travel supply chain. Our market leadership position in a challenging economic environment have afforded us a unique opportunity to expand our leadership position. It's an opportunity that we intend to capitalize on.

To that end, we issued a convertible note at the end of last quarter, raising an additional $287.5 million in capital. We expect to put that capital to work over the remainder of fiscal 2010 and fiscal 2011. We will invest that capital in strategic investments that accelerate our capacity to execute against the growth objectives that I just outlined. Successful execution against this market opportunity will drive compelling and sustainable growth in revenue, earnings and cash flow for years to come, creating compelling value for our long-term shareholders.

Obviously earlier today, we announced the appointment of Frank Pelzer to the role of Chief Financial Officer for Concur. As I stated earlier, Frank and I have worked together for nearly a decade. While his expertise in corporate finance, M&A and his broad technology background will be a tremendous asset for our company over the forward decade, what's most compelling about Frank is that he's cut from the same cloth as the rest of our executive team. Our culture, our shared values and our shared goals are what defines our company and enables our success. I am very pleased to welcome Frank to our team.

Today also marks the last earnings call for our retiring CFO, John Adair. I want to thank John for his contributions over the past decade and his commitment to our company, our customers and our shareholders.

With that, if you please turn to the next slide, I'd like to turn the call over to John Adair, our Chief Financial Officer. John will provide details on Q2 results, as well as our business outlook for 2010. John?

John Adair

Thank you, Steve, and good afternoon, everyone. The results for the second quarter of this year were exceptionally strong and meaningfully above our expectations. We continue to see evidence of stability in the early signs of recovery in the markets we serve. We also continue to believe that recovery in the global economy will be gradual and an even.

I'd like to cover three key messages in my prepared remarks today. First, Q2 financial performance was very strong with revenue, earnings and cash flow growth, coming in well ahead of our expectations. Second, we continue to expect the second half of the fiscal year to track according to our expectations as we discussed from the last two earnings calls. As you recall, we expect year-over-year revenue growth to be higher than Q3 and Q4, than we experienced in the first half of the year and we expect to continue to invest in long-term growth opportunities to drive top line growth rates above our stay-stay target over an extended period of time. And third, we announced today the appointment of Frank Pelzer to CFO of the business. This selection process has been very thorough and I'd like to provide you with some insight into our plans to execute a smooth and seamless transition. If you would please advance to Slide #14 and let's look at Q2 results.

Q2 revenue was well ahead of our expectations, $72.8 million, growing 17% over the same quarter of last year. Recognized revenues in the quarter benefited from higher than expected transaction volume, strong traction in new customer deployments, as well as existing customers adding on new services. Additionally, collections of accounts receivable were strong during the quarter, and accordingly, we saw a benefit to revenue as amounts collected on troubled accounts were better than our expectations. Customer retention rates also improved more significantly in Q2 than expected, as we saw a return to our historic retention rates in the mid- to high-90s during the quarter, our previous expectation was that we would achieve this rate during the second half of this fiscal year. Please advance to the next slide.

Both gross and operating margins this last quarter were in line with our expectations and continue to reflect the underlying strong long-term earnings power of the business. Our gross margin grew to about 70%, up sequentially from the prior quarter of this year. We also continue to execute well against our long-term growth initiatives that Steve previously enumerated, with investments in these areas tracking well. Our non-GAAP operating margin of 22.9% was consistent with our expectation for the quarter, and we continue to execute well against our expectation of 23% or more, for the year as a whole. With strong revenue and margin performance, Q2 non-GAAP pretax earnings were well above our expectations at $0.31 per share compared to our target of $0.28 per share. Please advance to Slide #16.

Cash flows in Q2 followed our strong earnings performance with cash flow from operations totaling $18.2 million. And after capital investments of $4 million, free cash flow was $14.2 million, up 35% sequentially. After a very strong start to cash flows in Q1, free cash flow on a year-to-date basis has accumulated to $24.7 million, up 46% compared to the same period of last year. As should be expected with strong revenue and earnings performance, our balance sheet also continue to grow stronger. Cash and investments, net of customer funding liabilities, grew approximately $7 million to $228 million by quarter and. And despite the continued challenges businesses face, as the global economy slowly recovers, cash collections were strong and days sales outstanding remained at 60 days, which is the low end of our 60 to 70 days expected range.

Based on strong revenue performance, as well as strong contract signings, deferred revenue grew to nearly $55 million by quarter end, reflecting 8% sequential growth and 24% growth over the same period of the prior year. As we announced just prior to the close of the quarter, we issued $250 million in convertible debentures due in April of 2015, bearing interest at 2.5%. This transaction closed shortly after quarter end. and accordingly, we have recorded the debt in a receivable for the proceeds on the balance sheet. Note that there was no P&L impact to this transaction in Q2.

We also issued an additional $37.5 million in debentures just after quarter end, with the exercise of the green issue. These will be reflected on our balance sheet in Q3. There are two items of note that I'd like to bring to your attention regarding the $250 million convertible debentures as recorded on our balance sheet at March 31. First, the fair value of the 2 1/2% debt components of the convertible instrument, totaling roughly $194 million, is recorded as long-term debt. Second, the fair value of the convertible component of the instrument, including the call spread to take the conversion premium to up 75% is recorded in equity as additional paid-in capital. A very detailed analysis of this transaction has already been provided in the announcements of the deal, which we filed in 8-Ks, will also be reflected in our 10-Q, which will be filed shortly. Please advance to the next slide.

Let's now turn the discussion to our outlook on Q3 and fiscal 2010 as a whole. As noted in our prior comments, the global economy continued to show signs of stabilization during the quarter, and in some cases, is now beginning to evidence the slow process of recovery. For example, as I noted earlier, customer retention rates returned to our historic norms during Q2. Conversely, the recovery has yet to register any significant new job creation and unemployment remains fixed at 9.7%. Although the pace and timing of this recovery will vary across the globe, across sectors and across market segments, we see signs in the markets that we serve that are consistent with the general market sentiments of gradual global improvement. The pace and slope of this recovery is also generally consistent with our expectations for this fiscal year. And accordingly, we remain very comfortable with our expectations for the remainder of the year, as previously discussed. Even considering that Q2 year-over-year revenue growth of 17% was stronger than expected, we expect revenue growth in Q3 to increase over that of Q2, reaching 18% over the same period of last year, and then improving even further in Q4 this fiscal year. We believe that as the global economy gradually regains its footing, there will continue to be opportunities for us to strengthen our leadership position, especially in new markets and through new service offerings, such as Concur Breeze. Accordingly, we will continue to increase our rate of investment in global distribution, new service offerings and service excellence, as Steve has previously discussed.

Note that with the issuance of the total $287 million in convertible debt, we will begin to recognize interest expense in Q3. That interest expense will be composed of two elements. First, the coupon rate on the debt is 2.5%, and including amortization of issuance costs, we will record approximately $2.1 million or $0.04 per share in quarterly interest expense. Second, Generally Accepted Accounting Principles require the recording of non-cash interest expense to equate the cash coupon rate to the estimated market rate of interest. Accordingly, we will record approximately $2.4 million or $0.05 per share in non-cash interest expense every quarter. On an after-tax basis, that quarterly non-cash interest expense will equate to approximately to $0.03 per share, which will factor out of non-GAAP earnings per share.

As a result of all the above, our non-GAAP pretax earnings for Q3 are expected to be $0.29 per share, including $0.04 of cash interest expense, as I'd just described, or $0.17 when tax effective at 36.5%. Our non-GAAP pretax earnings for fiscal 2010 as a whole are expected to be $1.20 per share, including $0.08 of cash interest expense or $0.77 when tax effective at 36.5%. As a reconciliation of our current and prior earnings expectations, note that our current expectations of non-GAAP pretax earnings of $1.20 would equate to $1.28 per share prior to the impact of our recently issued convertible debt offering. This represents an increase of $0.01 per share compared to our prior expectations of $1.27 per share. And our non-GAAP operating margin for fiscal 2010, we expect it to be 23% or more, keeping with our prior expectations.

While working capital will fluctuate quarter-over-quarter, cash flows for fiscal 2010 are expected to remain strong and continue to grow as annual earnings grow. Note that we will begin making the semi-annual cash interest payments on a 2.5% debentures starting in Q1 of the coming year. Based a stronger earnings and working capital performance, we are raising our expectations for cash flow from operations to now total between $75 million to $77 million, and after deducting capital expenditures of approximately 18 million, we now expect free cash flow to total between $57 million to $59 million, or an increase of approximately $2 million. Our cash tax rate is expected to remain in this low-single digits for fiscal 2010, as we continue to utilize tax NOLs to reduce cash tax payments. And while our GAAP tax rate was slightly lower for Q2, we expect our tax rate for the year as a whole, 336.5%. Please advance to Slide 18.

Steve noted earlier, we also announced today the appointment of Frank Pelzer to become our new CFO. I could not be more pleased with Frank's selection as the company's new CFO starting on May 17. I've had the good fortune to work with Frank for many years in his capacity as an advisor to the company, starting all the way back our acquisitions of Outtask and Gelco, our secondary offering in 2007, our acquisition of Etap-On-Line last year and many other instances along the way. Frank has proven himself as a strong financial voice and guide for the company. As I publicly stated many times, I could not be more passionate about the future of this business and I'm personally committed to making this transition extraordinarily successful. In keeping with our long-term view of this business, we will be very orderly and methodical in our execution of this transition.

And now in closing, with a very strong start to the fiscal year, this financial performance across the board exceeded our expectations. We've grown increasingly positive on the remainder of the year and expect Q3 and Q4 growth rates to be higher as compared to Q1 and Q2. We're also focused on specific long-term growth opportunities for our business, including growing our customer base in the markets we currently serve, geographic expansion, addressing the emerging business sector and expanding the range of services we deliver to our customers. And as such, we are investing aggressively across the business. Consistent with our expectations throughout this year, this investment will likely include any incremental margin that may be realized throughout the course of the year from over performance against our original expectations. With the raising of $287 million in new capital, we have increased our capacity to see the organic growth of the business through strategic acquisitions, in line with the growth initiatives I just noted. We expect to begin to put this capital to work in the coming year in a disciplined manner, that is consistent with our historic guidelines including areas of focus and financial expectations.

Operator, we'd like to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Steve Ashley.

Steven Ashley - Robert W. Baird & Co. Incorporated

I'd just like to start with a housekeeping question John you talked about accounts receivable and doing a better job collecting some of the more challenging accounts and that aided revenue in the period. I wondered if you could quantify that for us.

John Adair

During any given period of time, our reserve methodology is to take amounts for which we believe reserves are required. And as opposed to recognizing those reserves and bad debt expense as a G&A cost, our practice from a GAAP perspective is to record those adjustments as reserve revenue such that in the event that our collection efforts are a little stronger or better than what was previously expected, we see the adjustment through revenue. In the quarter itself, the amount was relatively modest. But it's not something -- usually by modest, I mean positive. But it's not something we necessarily expect to continue on a quarter-to-quarter basis.

Karl Keirstead - Kaufman Bros.

Does modest mean less than $1 million?

John Adair

Yes, certainly less than $1 million.

S. Singh

Way less than $1 million, just to be clear about it.

Steven Ashley - Robert W. Baird & Co. Incorporated

And then I wonder if you'd maybe could just talk about if we look at the American Express travel booking partnership in Europe, have you started to do some training of their people there? And maybe you could give us a little color on if that training is kind of done in person, is that something that can be done online and automated? Just a little color on around that.

S. Singh

Sure. We have started to work with American Express Business Travel on training the organization. And we've obviously seen some progress even in the first quarter, we saw growth coming American Express Business Travel. I think those are from an expectation point of view. We have to assume it's going to take multiple quarters to fully get both sides of the organization up to speed, and working well together. Having said that, it's nice to get the first handful of referrals in the first two months of the partnership.

Operator

Your first question comes from Laura Lederman with William Blair.

Laura Lederman - William Blair & Company L.L.C.

First question is the minimum, obviously, we're under pressure. Has that totally abated? And kind of theoretically, when would you start to see the opposite in minimums maybe going up? And I realize it's theoretical, but would love some help on that.

S. Singh

First and foremost, I think the point that John brought out in the call script, which is very important, is that our retention rate returned to a normal steady-state retention rate in the quarter. So that's obviously a very positive sign, that was full quarter ahead of our expectation. I think that as far as the concept of minimums, I don't think that you're going to see any kind of real difference on a going forward basis. Just like you didn't really prior to the recession kind of starting. In general, we really see a very, very modest variance from transactional volumes versus what we expect relative to expense report. Again, less than 1% has been our historical average. Obviously, we did see some transactional volume ahead of our internal plans, and that's really all on travel. Obviously, as you know, with the start of the recession, travel transaction volumes actually reached the low watermark of roughly 40% below their prior period. And we are clearly moving back towards that zero line of the watermark. And if I had to approximate, it will probably be about 40% of the way back to the watermark.

Laura Lederman - William Blair & Company L.L.C.

Totally different question which is acquisition for the past you acquired beautifully and very periodically. And with the increase money, do you plan to have multiple acquisitions? I guess what I'm trying to get at is the span of control of being able to acquire and acquiring well if you're going to acquire multiple things.

S. Singh

Sure. Obviously, we're entirely focused really on making sure we do an incredible job running this business. If you look at our history, the vast majority of our growth has really, over the past decade, has really been organic and we don't expect that to change materially over the next decade. In fact, frankly, the right way of thinking about M&A is our view is smart M&A is all about driving great organic growth. And you obviously see the evidence of that in our history. And I appreciate the comment that looked like we've done a really good job in the past with M&A not only in great customer retention, but also being able to pull the management team of those organizations into our management team. One of the things that I think is very helpful for us as we look out in the next 10 years is Frank Pelzer's background who's obviously a great background in corporate finance as well as M&A. I think Frank will add to the depth of experience we already have in our organization. Mike Koetting who we appointed as the Executive Vice President of Supplier Management and Advertising, will be very helpful in helping us navigate the travel on the side of the industry. So our view's that we'll continue to see us execute in M&A the same way you have in the past which is very, very methodical, very much in line with the principles that we use to decide what markets we want to get into, how we want to get into them and what financial objectives we want to hold ourselves to.

Laura Lederman - William Blair & Company L.L.C.

Can you give us a sense, theoretically, of when you expect to get back to kind of 20% revenue growth? Is it logical to expect that next calendar year or even fiscal year? And I realize you didn't give the guidance next year, but just a rough sense.

S. Singh

I think you heard John speak specifically to Q3 revenue guidance of 18% year-over-year growth. And we expect that trend up again in Q4. Of course, the objective is to trend back towards our steady-state growth target of 25%, but that's going to take a bit of time. 20%, I think you have to make your kind of estimates on this, but clearly there's a trend line that we're headed towards, we just finished the quarter in which we grew 17% year-over-year. So we're certainly headed in that direction.

Operator

Your next question comes from the line of Tom Ernst with Deutsche Bank.

Thomas Ernst - Deutsche Bank AG

Question on the AMEX partnership, but just in general. You've had other initiatives as well to help take you down into the lower end of the market. I'm curious how much success you're getting in penetrating some of the smaller customers?

S. Singh

Obviously, I think there's probably two ways to look that focus down towards the middle market and SMB segment or emerging business segment as we call it. We've done very well with American Express and with ADP going after the middle market, we still think we've got plenty of room to expand our presence there and expand our efficiency of reaching middle-market customers. On the emerging business category, obviously, that's a category we literally just started targeting about three weeks before the end of the quarter. We signed several hundred new Concur Breeze trials. As of the end of the quarter, it is still within a 30-day window for those trials to convert to paying customers. We will update everybody on that progress in the next earnings call. Overall, the right way of looking at is that this is a very big market segment. We've got a tremendous opportunity to reach that segment. We've got existing relationships in place that are helping us go after our SMB market broadly and you should expect us to continue to sign some additional relationships to further increase our penetration.

Thomas Ernst - Deutsche Bank AG

Is the general sense though that the mid market for you, the partnered-driven mid market is outgrowing the rest of the business?

S. Singh

I wouldn't say that there's any one piece of the business that's growing dramatically different than any of the piece of the business. We continue to see strong growth literally across all different sizes of customers and, frankly, across different geographies. But I think more broadly speaking, if you look at this and say, "Hey, look. What's the distribution, what's that bell curve of customer distribution look like?" Obviously, there's more customers as you come down in employee size. And so by definition, over the next decade, you're going to see a lot more customer growth coming out of the middle market and the emerging business sector than you will in the higher end of customer segment. But that's really nothing more than a reflection of where companies exists.

Thomas Ernst - Deutsche Bank AG

You mentioned ADP is -- with AMEX hitting the peak level, is ADP maintaining their strength as a channel partner?

S. Singh

Yes, ADP continues to be a great partner for us. We continue to see very consistent, solid results out of our relationship and don't see any reason that would change in the coming years.

Operator

Your next question comes from the line of Stephanie Withers with Goldman Sachs.

Stephanie Withers - Goldman Sachs Group, Inc.

I'm wondering if I could get a little more color on what kind of drove the upside in the quarter? Specifically could you give us any kind of split on how much revenue was driven by additional services into kind of your customer base or is it just new customer adds?

S. Singh

So if you look at the upside in the quarter that we saw, obviously, new customer growth that we saw several quarters ago, as it went live and those customers deployed, that had a positive impact on March quarter revenues. We also saw a positive impact coming from transactional volume in travel, being higher than we expected. And we obviously saw a positive impact with our retention rate reaching our steady-state target about a full quarter ahead of schedule, so those three core drivers of better than expected revenue result. We really haven't broken out nor is it really useful to break out how much came from each of those because that varies frankly from quarter to quarter, but those are the three biggest variables. And realistically, going forward, the two variables that will impact our revenue performance in any given quarter will be customer deployment and transaction volumes.

Stephanie Withers - Goldman Sachs Group, Inc.

And how should we think about pricing on those volumes as you sell more into smaller and more margin businesses, but then also are kind of selling more services into each new customer? How should we think about the pricing dynamics there?

S. Singh

Very much in line, frankly, with what we've highlighted in prior discussions whereas we priced the transactional model with price the per transaction being different based upon the number of services that our customer use. We don't, obviously, break out the detail of that just simply because we've got a lot of competitors listening in on the call and frankly defined a lot of there go-to-market approach through that. And so it's really driven by transactional price that is set based upon the value that the customers are actually consuming or the number of services they are consuming.

Operator

Your next question comes from the line of Mark Murphy with Piper Jaffray.

Mark Murphy - First Albany

Just a question on the dilutive effect of the convertible securities. I believe at this point, we're baking in two quarters worth of that effect into FY '10 numbers. And so just to be clear on this, I'm wondering what will the full year non- GAAP EPS impact be in FY '11 due to the converts relative to the current consensus of about $1?

John Adair

If you look at the impact of the convertible, just a couple of the components here, on a quarterly basis, we'll recognize about $2.1 million of cash coupon interest expense and about $2.4 million of a debt discount amortization. So about $0.08 in total on a pretax basis or about $0.05 in total on a quarterly basis on an after-tax impact. And so on full year, it's roughly four times at $0.05 or about $0.20.

Mark Murphy - First Albany

John, you haven't guided on that year, but I mean, is it advisable at this point for us to just take that number as it stands and drop it by about $0.20? Or you think that there are enough other factors to be considered around the strength of the business that that's not really necessary?

John Adair

Sure. I think on a GAAP basis, the impact will be as we described is about $0.05 per quarter on an after-tax basis.

Mark Murphy - First Albany

And then just as a follow-up, you commented that you see signs of stability and recovery. You have retention rates back at historical levels sooner than expected and you've got this benefit of the predictability from the subscription model. Is there any thought to reinstating an annual revenue guidance number just to be able to more effectively communicate the plan with shareholders?

S. Singh

Sure. At this point, my feeling is that we share enough information around the outlook of our business, both in the, frankly, near term, midterm and long term that our investors get a very good picture of what we expect. Obviously, specific and short term basis, we give our EPS expectations, the pro forma margin expectations, cash flow from operations expectations as well as the trajectory of revenue growth both from the near term and medium term. And so my feeling is that we provide more than sufficient information for investors to get a very good feel for the performance of our business. Broadly speaking, what we're trying to do is build, obviously, a great business, an enduring business over the long term. And we think those businesses are very well valued based on performance and not on expectations.

Operator

Your next question comes from the line of Ross MacMillan with Jefferies.

Ross MacMillan - Jefferies & Company, Inc.

Steve, you've obviously commented that you saw some of the outflows in the quarter from travel transaction. I think you said it we're about 40% of the way there. To be curious to get a sense for how much of the delta, if you will, from zero to 40 do you think kind of came in this quarter relative to, say, the last quarter. In other words, was it an acceleration? And then second of all, when I think about transactions driving revenue upside, I guess I have to think about it in two ways. One is standalone travel customers where you could see that transactional revenue maybe pick up more aggressively. And then second of all, T&E customer where it might, over time, influence volumes of T&E reports, I guess. Is that the right way to think about it? And is there any reason to think that coming out of the trough, it'll be any different than going into the bottom of the cycle?

S. Singh

First and foremost, as far as the trending to their watermark, I think we actually have a slide in the investor deck that accompanies the earnings call. That'll show you the quarterly comparisons from the year-ago period. And I think what you're going to see is, if I recall correctly, roughly in the June 2009 quarter it hit the low watermark or thereabouts, and then started moving back from there. So it's been a fairly gradual improvement since then. So it's not a one quarter event. That's number one. Number two, that business predominately are travel packed. So when we say, "Hey, look, transaction volume was higher than expected, " we're speaking merely to the travel transaction volumes. Obviously, in our expense reporting, side of the business, which is a vast majority of our business, our pricing, as you well know, which is basically -- it includes monthly minimums. So you don't see a lot of transactional variance on that. In fact, if you look at the historical patterns outside of some extreme scenarios in the early phases of the recession, you will see a 1% or less variants under those transaction. And I think that where we're at is that what you ought to expect going forward on the expense side. On the travel side, we expect it to trend back to the watermark by the late part of 2011.

Ross MacMillan - Jefferies & Company, Inc.

Just in terms of Michael Koetting's role, could you just talk a little bit more about what he'll be focused on and if that's a brand new role in the organization?

S. Singh

First of all, it is a brand new role in the organization. As I said on the call, Mike comes in as Executive Vice President of Supplier Management and Advertising. He's a 17-year vet in the corporate travel industry coming out of Carlson Wagonlit Travel. In fact, he's the COO for Carlson Wagonlit North America. We think that there are some very compelling opportunities around new revenue, opportunities in the emerging business segment for which we delivered our first product, of course, the Concur Breeze product. At this point, there's really not a lot more to say about that. This is an opportunity we think that we can capitalize on over the course of the next several quarters as far as defining what we want to do in this space, and how we want to go deliver these services. But I do think it's important to bring out that -- look, we don't expect to see any revenue impact from this particular initiative until 2012 at the earliest. This is highly consistent with the strategy that we've already discussed, right? And how we go to market in emerging businesses.

Operator

Your next question comes from the line of Robert Breza with RBC Capital Markets.

Robert Breza - RBC Capital Markets Corporation

Maybe just a quick housekeeping item, as you look at deferred revenue, the short-term deferred revenue had a nice sequential increase, almost 12%. The long-term deferred revenue was albeit down, just very slightly. I was wondering if you could just talk about the mix in deferred, what drove the short term up. And how should we think about that trending over the second half of the year?

John Adair

So if you think about the trending in deferred revenues, generally speaking, our expectation is in any given quarter, that trending is, as you recall, deferred revenues principally comprised of the monthly fee that we bill customers, one month in advance. And so as we continue to sell new customers or add on additional services to existing customers and then those services go live with customers and we begin to bill, we bill one month's component in advance, that one month advance billing goes into deferred revenue. And specific to your question, goes into the short-term deferred revenues. So the growth in short-term deferred revenues in any given quarter is principally driven by the deployment of new customers, adding on additional services, growing the monthly revenue base. And therefore, what you see in the balance sheet this quarter is the increase in the near-term deferred revenue growth.

Robert Breza - RBC Capital Markets Corporation

How should we think of that trending going into second half? I mean, would you expect it to be up consistent with your year-over-year type targets? I mean, 12% quarter-over-quarter growth was, obviously, very strong for the short-term fees and, obviously, indicating a great bookings quarter. Just trying to reconcile that with the 18% growth for June.

John Adair

Just to be clear, it's not necessarily related to new bookings in the quarter, but rather new customers going live in the quarter. And so the significant increase that you saw in sequential revenue this quarter is very much reflected in the growth in deferred revenues. On any given quarter, that growth in deferred revenues will fluctuate based on new customers going live, revenue growth in the quarter. It's always just timing, the billing for those revenues. So you will see it fluctuate slightly on a quarter-over-quarter basis. But what's really important is not the quarter-over-quarter trend, but the year-over-year trend. And so you should expect to see that continue to grow as the underlying revenue stream of the business grows.

S. Singh

Let me just add one thing to that, that is our deferred revenue trend, you simply don't translate to what the deferred revenue trends from those stats companies translates to. So I want to just make sure that that's clear.

Operator

Your next question comes from the line of Sid Parakh for McAdams Wright Ragen.

Sid Parakh - McAdams Wright Ragen, Inc.

Question on operating margin, given that you're talking about accelerating revenue growth going forward, how should we expect operating margins to behave?

S. Singh

First of all, I want to make sure we point out that the revenue growth acceleration is very much in line with the growth that we highlighted at the beginning of the fiscal year, which is you'd see higher growth in the second half versus in the first half. Obviously, we've outperformed a bit in the first half. And what we're guiding to is 23% or better both from the operating margin for the year as a whole. We have been roughly at that number for the first half of the year so the expectation then, or in conclusion to be drawn is we should expect pro forma operating margin for the second half of the year to be roughly 23%.

Sid Parakh - McAdams Wright Ragen, Inc.

Steve, I was thinking more about longer term. You have said on the last two calls here that you do expect revenue growth to be higher than what you stated in the past. And considering that picture, I'm looking really more over the next three years rather than the next couple of quarters.

S. Singh

Yes. Sid, we just haven't yet provided any insight into what we expect 2011 and 2012 to look like. So our comments are focused right now on 2010.

Sid Parakh - McAdams Wright Ragen, Inc.

Can you also talk about just from a services standpoint, the new ancillary services that you're adding. How many of the new customers actually signed on to, say, the full suite of services versus just picking the T&E portion of it.

S. Singh

One last thing on the operating margin, pro forma operating margin, if what you're driving at is towards the long-term pro forma operating margin target, there's actually zero change there. We still think that we can go up and deliver 30% plus long-term pro forma operating margin. Coming back to the question on the product mix, it's very much in line with what we've seen over the last several quarters which is 60% plus of our customer base is picking multiple products. Obviously, the Travel and Expense tends to be the minimum for those 60% plus. But we also see a lot of our customers also use the Concur Pay. In fact, the vast majority of our deals, we see that as well.

Sid Parakh - McAdams Wright Ragen, Inc.

Just from an acquisition standpoint, is it fair to expect most of your acquisitions to be smaller as well as accretive window?

S. Singh

I think it's premature right now to say what those acquisitions will look like. We certainly have a track record of how we do deals and I would point to you in our investments back to our track record of how we do deals. I think that it's also fairly straightforward to understand the markets that we're interested in. We're obviously very, very focused on the corporate, travel and expense management market, on driving efficiencies to the corporate travel supply chain, and that's where you should expect us to be acquisitive. The size, frankly, can vary. It'll depend on the particular opportunity and the timing of that opportunity. Our focus is is it the right fit for our strategic goals and objectives? And can we execute exceptionally well on that particular transaction?

Operator

At this time, there are no further questions. Mr. Torrey, do have any closing remarks are?

S. Singh

John and I would like to thank you and all of our investors for joining us on the earnings call today. We look forward to updating you on the progress of our business at the July earnings call. Thanks so much everyone.

Operator

This concludes today's teleconference. You may now disconnect.

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Source: Concur Technologies Q2 2010 Earnings Call Transcript
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