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Rally Software Development Corp. (NYSE:RALY)

Q1 2015 Earnings Conference Call

June 5, 2014 5:00 pm ET

Executives

Jeff Cooper - VP of Finance

Tim Miller - Chairman and CEO

Jim Lejeal - CFO

Analysts

Nandan Amladi - Deutsche Bank Securities

Mark Murphy - Piper Jaffray

Michael Huang - Needham & Company

Alex Zukin - Stephens Inc.

Richard Baldry - ROTH Capital Partners

Patrick Walravens - JMP Securities

Operator

Good afternoon, and welcome to the Rally Software First Quarter Fiscal Year 2015 Earnings Call. Today's call is being recorded. At this time, I'd like to turn the conference call over to Jeff Cooper, VP of Finance at Rally Software. Please proceed.

Jeff Cooper

Thank you, operator. Good afternoon and welcome to the fiscal first quarter 2015 Rally Software earnings call. Our press release, CFO commentary, and a simultaneous broadcast of this call can be accessed on our Investor Relations Web-site at investors.rallydev.com. On the call today are Tim Miller, our Chief Executive Officer, and Jim Lejeal, our Chief Financial Officer. After the prepared remarks, we will open the call for questions.

Our commentary today will be on a non-GAAP basis for all costs, gross margins, operating and net income, as well as EPS, unless we state otherwise. Reconciliations between our GAAP and non-GAAP results and guidance can be found in our earnings press release. During the call, we may offer additional metrics to provide further insight into our business or results. This detail may or may not be provided in the future.

The purpose of today's call is to provide you with information regarding our fiscal first quarter 2015 results. Some of our comments may contain forward-looking statements which are based upon information available to us as of today's date and are subject to risks and uncertainties.

Should any of these risks or uncertainties materialize or should our assumptions prove to be incorrect, actual Company results could differ materially from these forward-looking statements. We encourage you to review our filings with the SEC for additional information on risk factors that could cause actual results to differ materially from our current expectations.

With that, I will turn our call over to Tim Miller, our CEO.

Tim Miller

Thanks, Jeff, and welcome everyone. Thank you for joining us today. Let me start by saying, Rally is a truly exceptional company with exceptional people and great products. We have a market leading solution that uniquely solves some of the toughest challenges of the largest companies on the planet. My conviction in our ability to win in our current market and expand into adjacent markets is stronger than ever.

While the opportunity is clear, our recent execution has fallen short of our high expectations. I take this personally and I am committed to improving. We must grow our business faster. I've been very candid with all Rally employees that we must make bigger commitments and deliver. This is a core value of Rally called 'make and meet commitments' and I can assure you we'll be laser-focused on doing that.

We all know that we are in a period of transition and Q1 was an important step in this journey. There were some positive signs in Q1 and some areas of concern. On this call today, I intend to talk plainly to our positive signs and highlight them, but also discuss areas of concerns and actions we're taking to improve. I'll summarize our financial performance and Jim will go into the details later. I will also speak to our product roadmap which is critical to our market success. So with that, let me highlight some of the areas of positive performance.

Seat adds; we delivered strong seat adds in the quarter and this was largely due to the strength of add-on orders to existing customers. As you all know, we have a land and expand story and it is great to see some of our highest potential customers add seats so quickly. I will discuss some of these customer wins a little later in the call.

But focusing on this area of the business is instructive to the primary growth driver in our driver. At the close of the quarter, our top 15 customers had 88,000 total paid seats. If you compare this total to the same group one year ago, the year-over-year growth rate was 41%. This same group grew 15% on a sequential quarterly basis.

Profitability and cash spend; we substantially beat our EPS outlook and this was the result of being disciplined about how we spend and invest in the business, and going forward we will invest with discipline, taper our investments as we move through the fiscal year, and in no way put the business in a situation where we need to raise additional capital from a position of weakness.

Let me turn to a couple of areas where we could have done better. New customer seat adds. We fell short of our expectations with respect to new seats sold to new customers. As we discussed in our last earnings call, we've made significant investments in our sales and marketing engine. We have new sales teams working new territories and [it was dropped] (ph) as a result we were seeing sales cycle take a bit longer, although this was not surprising.

We anticipated that our sales headcount growth would cause some execution delay as our new sales reps trained and learned new territories while seasoned reps learn to work with new team members. It takes time but we are excited about the quality of our sales teams and we are confident in these investments and at the lay of foundation for stronger performance in the future.

Renewals; in Q1 we experienced a few non-renewals which had a negative impact on our seat renewal rate. While our seat churn rate, which includes downgrades and non-renewals, did not increase from the number we reported in Q4, we expect better. We have made changes to ensure that we are in front of renewal opportunities earlier in the sales cycle, and to address this aspect of our business, we added a senior inside sales leader at the end of Q4 who over the course Q1 has staffed a strong renewals team.

Service revenue and margin; while service revenue was in line with street expectations and grew 31% year-over-year, we fell short of our internal expectations. Through the course of last year, we added capacity in this part of the business to meet our growth goals. As a result of this increased capacity and slight shortfall in revenue generation, we saw our services margin drop to breakeven on a non-GAAP basis.

From a business measurement perspective, my assessment is similar but more positive. We have a number of bright spots in the business and some areas to continue to work on. All of this work is designed to capture growth in the second half of the year and is setting this foundation continued accelerating growth into fiscal '16.

Positive areas in the business that I'd like to call out are the foundation we built in sales and in marketing where as a result of Angela Tucci's leadership, our new CMO, we have oriented the marketing function of the business to be hyper-focused on revenue generation. From a sales foundation perspective, I've already touched on the increased headcount we undertook in Q4 of last year and Q1 of this year to set the stage for growth. This additional capacity, assuming we've hired effectively and ramp these team members according to plan, is the bedrock for growth we expect to see starting in the second half of the year.

I will also call attention to the new leadership in our Australia, New Zealand and Europe regions where we've hired deep domain experienced and seasoned sales executives to lead these regions. International business is important to us as we grow and these new leaders are already demonstrating that they are more than up to the challenge.

From a marketing perspective, the positive areas are go-to-market in nature. We've taken action to tightly connect revenue generation with all go-to-market activities. I'm confident that the improvements we've made in this area of the business will pay off.

Rationally, and this is positive, we're seeing the signs and signals that we're turning the corner. The investments and the progress we've made lay the foundation to achieve our overarching goal, that is to maintain our market leading position and achieve accelerating growth in the second half of this year and into next year fiscal 2016.

Finally, you should all know that we have made difficult but necessary changes in the engineering organization and I am now leading R&D until further notice. I am excited about our product backlog and I'm making sure these compelling new features get to market efficiently as a top priority.

The commitments we've made to our customers in this domain are critical to our success and include enhancements in our user-interface that make our solution more enjoyable to use; improvements to our offering that help developers do their job efficiently; benchmarking and analytics functionality that allow us to sell higher and faster to our customers; progress on our portfolio functionality, again enhancements that allow us to sell higher in the customers' buying hierarchy; and lastly, getting Flowdock into the hands of all of our customers.

All of these areas of focus are critical and I am personally committed to helping lead this area of the business to deliver. I am confident in my ability to provide leadership to the team while we simultaneously conduct a national search for a new leader.

Regarding our financial results, total revenue for the first quarter was $19.4 million, within our outlook range set during our Q4 earnings call, posting 21% year-over-year growth. For the quarter, net loss on a non-GAAP basis was $6.8 million, or a net loss per share of $0.27 per basic and diluted shares, meaningfully better than our outlook set in our Q4 earnings call. We added just under 12,000 paid seats in the quarter, ending the period with a total paid seat count of approximately 226,000 seats. This represents a 23% increase over our paid seat count of approximately 184,000 seats at the close of Q1 of last year.

As I've stated in the past, not all our customers allow us to name them publicly but new customers we can name that we closed in the quarter include, Black & Veatch, Core Media, the Driver and Vehicle License Agency in the U.K., eTouch, PowerNet Global, Smartshift Technologies, Snag-a-Job, SpiritClips and Ubiquity Broadcasting.

We enjoyed substantial expansion in a number of accounts again this quarter. First, I'm pleased to announce that the number six customer on our top 15 customer list by paid seats, one of the nation's largest wireless telecommunications providers, renewed their 5,000 seat agreement with us and added an additional 7,000 seats. As a result, this customer is under contract for a total of 12,000 seats and now shares the number three position on our top 15 customer list.

The total annual value of this contract is approximately $3.7 million and included approximately $250,000 of services. This deal was competitive against IBM and the Rational Team Concert offering, but the customer's desire for an enterprise solution at scale, purpose build for Agile, and a trusted partner to help them successfully continue their agile journey gave Rally our win. This account has an identified seat potential of approximately 25,000 seats, so at 12,000 paid seats we believe we are approximately 48% penetrated and still have an additional 13,000 seats to sell to this customer.

I'm pleased to announce that once again Q1 saw continued penetration in two customers we referenced in the earnings call reports over the last couple of quarters. The customer we've referenced in the past calls is a large multinational financial services and credit card processing company, upgraded 2,000 seats in three separate orders over the course of the quarter, taking the customer to a total of 5,000 paid seats. This customer is rapidly adopting Agile and our offerings and our pipeline visibility indicates this customer is staging for additional orders of both seats and services in the coming quarters.

Recall that we landed this customer in Q3 of last year with an initial seat order of 1,500 seats, the largest initial order in the history of our business. This account's identified seat potential is now estimated at over 8,000 seats, so there's still significant upside potential left with this account.

The customer we've referenced in past calls is one of the world's largest automaker, once again upgraded an additional 1,000 seats. This customer now has a total of 2,150 paid seats and identified seat potential now estimated at 6,500 seats and is poised to become one of our top 15 customers by paid seats once they process their next order which we're actively discussing with them.

Our existing large Asian based global information and communications customer that signed a three-year contract with us last year did indeed take delivery of the 2,000 seats associated with their contractual second tranche, indicating the continued success we are having helping this global conglomerate go Agile. We will see the revenue impact of this transaction in Q2. You will likely recall that we have a third tranche of 2,000 seats the customer is due to take delivery of in Q2 of next year. We're actively discussing expansion with this customer as well and believe the potential for this customer to accelerate delivery on the third tranche is high.

Regarding our competitive landscape for deals flagged by our sales reps as competitive, Q1 analysis shows we won 36% of these deals and 63% of the dollars that were a challenge. We continue to have high confidence that Rally is the go-to solution for large enterprises going agile. With respect to our win rate against IBM, in Q1 we won 11 out of 16 deals for 92% of the dollars.

With respect to our business outlook, we will be lowering our revenue outlook to a range of $87 million to $90 million for the fiscal year. This is largely due to softness in services and perpetual revenue. Perpetual revenue in particular is difficult to forecast, especially given the price increase we announced for Q3 of last year. Given our top line outlook, we have taken a more disciplined view with respect to expenses and as a result we now expect our non-GAAP EPS range to be negative $1.31 to $1.36. Jim will walk through our outlook in more detail.

Finally, before I turn the call over to Jim, I'll highlight that RallyON, our customer conference scheduled to start this coming Sunday in Washington DC, is staged to be a significant event for us as it is every year. RallyON is a conference for decision-makers leading their organization's agile transformation. If you're planning on attending, be prepared to mingle with a number of our largest customers and significant prospects taking a serious and studious deep dive into the world of Agile, lean development and business agility.

This concludes my prepared remarks, and now I'd like to hand it to Jim to go over our first quarter financial performance in more detail and our outlook for the coming period.

Jim Lejeal

Thanks Tim. At the outset, let me note that we have made available a CFO commentary that supplements our earnings call press release we released this afternoon. You will note this material summarizes most, if not all, of my commentary today. Our goal here in releasing this supplemental material is to assist you in following my commentary and improve our dialog with you as we discuss the Company's performance.

I remind us all that my review and discussion will be on a non-GAAP basis for all costs, gross margins, operating and net income as well as EPS, unless I state otherwise. As Tim outlined, Q1 represented a continuation of some key trends we noted in Q4, notably we delivered meaningfully in the areas of renewals and upgrades with large accounts. I'll start with a review of our key metrics.

As we've said, we believe total paid seats is a key indicator of our market penetration, growth and future revenue. We define a paid seat as a seat with a subscription or support contract as of the measurement date. We ended the quarter with a total paid seat count of 225,963 seats. This seat count represents a 23% year-over-year increase when compared to 184,145 seats under contract at the close of Q1 of last year. The 11,916 seats added in the quarter represent an increase of 6% over the seats under contract at the end of last quarter.

We offer our renewal rate on a quarterly basis to provide insight into our ability to meaningfully grow our existing customer base. We calculate our renewal rate by comparing the total number of paid seats of all of our existing customers at the beginning of a 12 month period to the number of paid seats for the same customers at the end of such period, taking into account non-renewals, upgrades and downgrades. As of April 30, 2014, our renewal rate calculated against this customer cohort was 114%.

Moving to the income statement, total revenue for the quarter was $19.4 million which represents a 21% year-over-year increase over the same period last year. Subscription and support revenue for the quarter was $16.1 million which represents a year-over-year increase of 20%.

Perpetual revenue for the quarter was $639,000 which represents a year-over-year increase of 2%. As you know, the majority of our product revenue comes from annual licenses and therefore shows as subscription and support revenue. However, we do expect some customers to buy perpetual licenses. The revenue associated with this licensing model is lumpy and hard to predict. Large deals can significantly impact this revenue line, given the revenue recognition pattern of this license option.

Services revenue for the quarter was $2.7 million which represents a 31% year-over-year increase. In fiscal year '14, as a result of the added capacity and increased efficiency, we were able to deliver meaningfully against our services backlog. We expect to see continued strength in services in this fiscal year, as we continue to build our backlog. We believe services are a critical component of our customers' agile transformation.

Calculated billings, a non-GAAP measure which we define as revenue plus the change in deferred revenue, closed the quarter at $18.4 million, representing a year-over-year increase of 3% as compared to the first quarter of last year. In the past, we have normalized billings only for the impact of prepaid contracts. However, this is only one significant variable that impacts billings. When we normalize for prepaid contracts in Q1, our normalized calculated billings is $19 million, representing a year-over-year increase of 7% as compared to the normalized billings in the first quarter of last year.

In addition to multi-year pre-pay contracts, two other factors that can impact billings materially are add-on orders that co-term with the original contract that expires in less than one year and contracts that are off balance sheet in nature. For example, in Q1, we saw a material seven-figure annual contract where the customer needed to be billed in arrears and as a result the entire value of this contract resides in off balance sheet deferred revenue. This is the $3.7 million deal with a top 15 customer Tim outlined earlier in the call. The increase in contract value closed this year was approximately $2.1 million.

Gross profit for the quarter was $14.6 million, as compared to $12.7 million in Q1 of FY '14, reflecting an increase of $1.9 million or 15%. Total gross margin for the quarter was 75%. Our product gross margin was 87%, and our professional services margin was break-even which is largely a result of increased capacity added at the end of last fiscal year.

Now I'll turn to operating expenses for the quarter. Sales and marketing expense was $11 million, representing a year-over-year increase of $2.2 million or 26%. This increase was driven mainly by increased headcount across our sales and marketing organizations and variable spend in our lead generation activities. As a percentage of revenue, sales and marketing expense was 56% for the quarter, as compared to 54% for the same period in fiscal year '14.

Research and development expense was $5.6 million, representing a year-over-year increase of $700,000 or 15%. This increase was driven mainly by increased headcount as we continue to invest in product development. As a percentage of revenue, R&D expense was 29% for the quarter, as compared to 30% for the same period in fiscal year '14.

G&A expense was $4.7 million, representing a year-over-year increase of $1 million or 27%. This increase was driven mainly by increased headcount to support our growth and certain legal, accounting and insurance expenses related to operating as a public company. As a percentage of revenue, G&A expense was 24% for the quarter, as compared to 23% for the same period in fiscal year '14.

Net loss for the first quarter was $6.8 million or a net loss per share of $0.27 per basic and diluted share. We are currently generating a net loss, and as such our basic weighted average shares outstanding for the first quarter was approximately 24.8 million, which does not include the impact of vested stock options. If we were profitable today, our fully diluted share count would have been approximately 25.6 million shares when applying the treasury stock method to these vested options.

Cash flow from operating activities was negative $2.8 million for the quarter, as compared to cash flow from operating activities in Q1 of last fiscal year of positive $1.4 million.

Turning to our balance sheet, as of April 30, 2014, our total cash, cash equivalents, excluding restricted cash, and accounts receivable balance was approximately $101.8 million, as compared to $110.7 million as of January 31, 2014, and $115.4 million as of April 30, 2013. We currently carry no bank debt.

We ended the quarter with an accounts receivable balance of $16 million. Total deferred revenue decreased $300,000 year-over-year to close the quarter at $39.7 million. Short term deferred revenue increased $3.1 million year-over-year to close the quarter at $38 million. Our days sales outstanding was 78 days at April 30, 2014 as compared to 59 days at April 30, 2013.

With respect to headcount, we added 36 employees during the quarter for a total Company team headcount of 494 employees. We increased sales headcount 36% year-over-year to 166 employees at the end of the quarter.

Let's turn to our outlook for the second quarter of fiscal year '15. For the second quarter of fiscal year '15, we currently expect revenues between $20.2 million and $20.8 million, representing year-over-year growth between 2% and 5% over Q2 fiscal year '14 revenue of $19.8 million. For the second quarter of fiscal year '15, we currently expect a non-GAAP net loss per basic and diluted share between negative $0.39 and negative $0.42 with weighted average shares outstanding of approximately 25 million shares.

As Tim outlined earlier in the call, we are revising our full year revenue and EPS outlook. For the full year fiscal year 2015, we currently expect total revenues in the range of $87 million to $90 million, representing year-over-year growth between 17% and 21% over fiscal year 2014 total revenue of $74.3 million. For the full year fiscal year 2015, we currently expect a non-GAAP net loss per basic and diluted share between negative $1.31 and negative $1.36, with weighted average shares outstanding of approximately 25.2 million.

Regarding upcoming conferences we are attending, we attend conferences when they are scheduled outside of the moratorium phase of our quarterly quiet period and you can expect to see us at the William Blair Conference next week and the Deutsche Bank Conference in September. If you are available to meet at these conferences, please let us know.

This concludes my prepared remarks, and I'll turn the call back over to Tim.

Tim Miller

Thanks Jim. I'll summarize by saying, I want you all to know that I am personally committed to returning Rally to its high growth performance profile. Our solutions enable our customers to win in their respective markets, our customers count on us to help them innovate, deliver superior products and services and ultimately to deliver business agility. We don't plan to let our customers down and we don't plan to let you, our investors, down. We will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question today comes from Nandan Amladi from Deutsche Bank. Please go ahead with your question.

Nandan Amladi - Deutsche Bank Securities

First question was on the off-balance sheet. This is something that you've not described before. How does this compare with historical trends and should we consider this as a one-time event, and if so, would it be fair to include it in your normalization calculation?

Jim Lejeal

This is Jim. It's a rare event that we would bill and invoice a customer in arrears and allow it to go to off-balance sheet in the way that this deal went down. If it becomes a trend, then I will factor it into my normalized mathematics, if you will. The increase in the contribution to the billings this fiscal year is around $2.1 million, as we said in the prepared remarks. And if you also factor in the stub period dynamic of the in-term orders that the credit card company executed during the course of the quarter and you normalize for those two effects, you'll get to a calculated billings in the zone of just over 18%, and hopefully that's helpful. If it's a trend, you can expect me to factor it into the discipline of normalized billings discussion in future calls.

Nandan Amladi - Deutsche Bank Securities

Thank you and I have a quick follow-up. You also changed your OpEx outlook. Is that predicated on you making significant changes to your plan from last quarter, because honestly the feedback we got from many investors was that the OpEx profile was raised to a level that didn't seem realistic on the last earnings call?

Jim Lejeal

Yes, I think that's fair to say. The discussions we had with investors as well commented concern about the amount we were investing. We expect to taper through the course of this year in a careful way, investing meaningfully in sales and marketing but tailoring or tapering back in R&D and G&A, and you can expect that to enable us to meet the revised lowered or better than EPS outlook that we offered.

Operator

Our next question comes from Mark Murphy from Piper Jaffray. Please go ahead with your question.

Mark Murphy - Piper Jaffray

Jim, could you walk us through the guidance reduction on the top line and trying to quantify the change we should apply to the perpetual license line and also the service line?

Jim Lejeal

I'll start by saying, Mark, I'm not going to give a mix guidance at this point. I'll do that once we completed the second quarter of the year and we'll do that to help us all think about the remainder of the year. As you can tell from the math, the midpoint in the outlook is dropped by 4 million and that has the corresponding impact on the Q2 outlook. I think if you think thoughtfully about how the subscription and support revenue pattern of the business has grown in past quarters, it will help you get an understanding of what Q2 will perform at in this range. And then with regards to revenue in perpetual and services, you'll have to make your best estimates with regards to how you think that will perform.

Mark Murphy - Piper Jaffray

Okay, so Jim, what was your comment again on – I think you said, a large proportion of the change in the guidance was due to, was on the services and the perpetual license line, did I capture that accurately?

Jim Lejeal

Yes, you did.

Mark Murphy - Piper Jaffray

Can you ballpark if the reduction I think you're saying is about 4 million, how much of that we could allocate to the perpetual license and services lines?

Jim Lejeal

We're just not providing the detail, Mark, on the component revenue, but like I said, I'll do that, I'll give us mix input at the end of the Q2 call.

Mark Murphy - Piper Jaffray

Okay, so then let me try to ask this way, Jim. I think you're saying the typical subscription revenue seasonality for Q2 could inform the way we're going to [indiscernible] Q2 this quarter, are you expecting us to make a slight downward reduction in the subscription and support forecast for carrying through the second half of the year?

Jim Lejeal

I think it's fair to be cautious about how you're modeling year out quarter Q3 and Q4 in subscription and support, I think that's a fair characterization.

Mark Murphy - Piper Jaffray

Okay. Tim, can you walk us through what happened with your commentary on the – it sounds like there was a change in R&D leadership, did I hear that right or what is the change that you were describing there?

Tim Miller

Sure. So first of all, just to shed a little context, I have a background leading engineering teams. That's how I spent the first 10 years of my career. I implemented Agile processes and teams back in 1991. So this is a natural strength of mine. We've retooled sales and marketing over the last several quarters, and while those results haven't delivered yet, I am confident in that team and I believe we are on the right track.

So that work has freed me up to focus on the core driver of our results, which is our product. We have an enormous amount of product capability in various stages of delivery, and how we go to market with that over the coming months I think is critical to ensure we maintain our market leadership and reinvigorate growth. So I'm taking a deep dive on that right now, and honestly, I'm very invigorated by it and really enjoying that work.

Mark Murphy - Piper Jaffray

Okay. One final one for me, I guess on the topic of the new business from the new logos. Would you describe it as – do you feel as though you're seeing the leading indicators, size of funnel, pipeline, lead flow, all of that, are those trending in the right direction and it's just the close rates towards quarter end that are kind of suffering, or is it more a combination of the two?

Tim Miller

So as we said, our expand part of our business is doing well. The new deals from new customers not where we want it to be. When we think about the out funnel, there's a couple of things going on that I can share. One is, we do have more discipline in our sales force. As a result of that and I think some other things that make us feel good about the business, we see a pretty dramatic increase in our pipe in out quarters, meaning two and three quarters out. This is new and I believe we can associate this with our new sales teams working on large strategic accounts, but they take time to develop. So, I see this as a healthy sign for the future but we're still encountering softness even in the current quarter, and that's why we've guided down in Q2.

Mark Murphy - Piper Jaffray

Jim, the beauty of the subscription model is the predictability and the visibility that it affords to you. Do you feel in making the downward adjustment that you're making here, do you think you have left some room for certain elements of the business to potentially take some time or trend the wrong way next quarter, or are you embedding an expectation of a sudden dramatic incredible resumption to a new kind of powerful strengthening trend in the business?

Jim Lejeal

No, I would characterize it as leaving a little bit of room. We hired a lot of quota carrying headcount in Q4 and Q1 and it takes time for those folks to ramp, as we've talked about a lot with many of you. And so, clearly those quota carrying heads need to contribute to the business in the back half of the year, but I believe there's a little bit of room from a subscription and support standpoint.

Mark Murphy - Piper Jaffray

Thank you.

Operator

Our next question comes from [Matt Fowl] (ph) from William Blair. Please go ahead with your question.

Unidentified Analyst

First one on the sales execution issues. What gave you guys confidence that this is really just an issue with your sales force and that it's not something else such as competition or an issue with the product or anything?

Tim Miller

So as I said, we're generally working great wins on our expansions, and obviously we're too small a company to live off of this base, we need new accounts. So, this investment in the new expanded sales force happened late in the year. We got a little bit behind the curve and backend loaded, but we've hired fast in order to get those folks onboard. This team is much stronger, they are working on new prospecting, on new accounts, and we're seeing early indications that that's working.

For example, when we think about sort of customers named accounts and ones that have the potential to be really large, we added 23 new customers in that sort of category, of which 16 are named. Those are early indications that those are going to be big customers for us, but we need to see more of that and we need to see it more quickly.

Unidentified Analyst

Okay, and then was it just a factor of deals not getting signed being pushed out or were there any deals lost from the quarter?

Tim Miller

It's sort of all over the map. Clearly as an enterprise software company, we see a lot of deals closing up at the end of the quarter, some number of those pushed into this quarter. We did see a healthy competition. We addressed that a bit. There was a slight increase in competition. I think generally we would categorize that as, the pressure and the heat in our market as a result of our IPO and our market leading position has forced us into a little bit more competition, but not a significant trend that we can comment on today.

Unidentified Analyst

2

Okay. And then, the execution, it sounded like you may have alluded to that it was both from the new reps and then the existing reps seemed to have some issues adjusting to the new territories. Is that a fair assessment?

Tim Miller

Yes, so it's fair to say that we changed territories, we changed teams, we changed quotas. We had a lot of change coming into this year. So, there was some impact on new and old alike.

Unidentified Analyst

Okay, and last one for me, just a clarification on a comment earlier about the change in earnings guidance. So if I heard correctly, it does seem like that you may have decided to scale back your sales hiring a bit from the original plan that you had last quarter. Is that correct?

Jim Lejeal

No. Matt, I'm glad you asked the question to offer the clarity. I would characterize it as, we are still meaningfully investing in sales and marketing, and where we are tapering our investment is in R&D and G&A as a percent of revenue. So, if you compare today Q1's outcome to where we will be at the end of the year, let's say Q4, you'll see a meaningful drop in R&D as a percentage of revenue spend for the quarter and G&A.

Tim Miller

This is Tim. I just want to make clear too, I mean on an absolute basis, we're continuing to hire aggressively on a relative basis. That's how we think about the discipline that we're adding into the model.

Unidentified Analyst

Got it. Thanks for taking my questions, guys.

Operator

Our next question comes from Michael Huang from Needham & Company. Please go ahead with your question.

Michael Huang - Needham & Company

Just a few questions for you here. I don't know if you're going to provide this for us, but since you shared the 20 new customers with 16 named in this past quarter, I was wondering if you could provide the metric for lat year same period, I mean how does it compare?

Jim Lejeal

This is Jim, Mike. I'll jump in here. The notion of a named account is a new concept I think that was introduced by Dan Patton, our EVP of Sales, let's say through the course of Q4 last year. So recall that when we talk about this area of the business in past quarters, and as we set up for the fiscal year '15, Dan implemented what I would characterize generally across the board higher level of discipline, one of which being that territories needed to have written and thoughtful account plans for the Fortune 1000 companies that exist in their territories. In a way, these territories now are focused on those accounts.

And recall that we are a land and expand business model and our average initial seat order generally I think for the most recent period that I can remember in terms of the analysis, the average initial seat order is 80 seats. So you can imagine what these territories are doing there, targeting Fortune 1000 companies, they are landing in a small way and it's those accounts that turn into significant accounts over the course of the future.

The wireless company that Tim highlighted in the call today, that's a customer that started with us five, six years ago with an initial 25 seat order. So, think of it as a higher order discipline targeting accounts where we ought to have a presence.

Michael Huang - Needham & Company

Got you, okay. So with respect to the companies you're around, some of these named accounts or strategic opportunity that you're developing nicely for the second half, should that translate into a bigger initial seat count order or is it just the seat potential that ultimately is kind of where we should be focused?

Tim Miller

I believe over time, not giving any specific guidance on when, we'll see more new deals to new customers that represent significant seat opportunities as a metric that we'll track internally and perhaps think about how to characterize that in the future that will ultimately drive long-term growth. Again, we've been really good with our existing customers and growing them. We'll continue to focus on that part of the business, but when I look at my new role as a VP of Engineering, I am really focused on getting a lot of the value that we have in some alpha and some beta programs out to new customers in order to win them coming into Rally, and then once we do, obviously want to grow them fast.

Michael Huang - Needham & Company

Got you, okay. And then last question for me, so kind of with respect to renewal activity and maybe some of the non-renewal, I think you're pulling up a renewal team to help focus on this. Could you characterize what are some of the reasons that you're seeing for some of these non-renewals and how does the renewal team help address this?

Tim Miller

We see pretty similar attributes for a long time. We see price, we see functionality, we see usability, some of the core product things that I'm focused on, those capabilities are important to us. One of the things that we haven't paid as much attention to, we've delivered some really terrific products and capabilities for enterprises at scale and continue to dominate in that market, we need to deliver those features for smaller teams. I think we'll be able to do that on very short orders. We have a lot in the pipe that we can deliver. That capability I think will have a material impact on improving our renewal rates, especially in the smaller customers where we had much more churn historically.

Michael Huang - Needham & Company

Got you, okay. Okay, great, thanks guys.

Operator

Our next question comes from Alex Zukin from Stephens. Please go ahead with your question.

Alex Zukin - Stephens Inc.

I wanted to drill a little bit about the increased competitive pressure that you talked about. If we segment that in to the competition from the more established legacy vendors or from private competitors, where would you say you're seeing more competition?

Tim Miller

So if you think about sort of the established legacy, IBM, HP and CA, we continue to compete very effectively and we pay attention to that because ultimately we think those are folks that are going to be able to compete at the scale of the organizations that we ultimately want to win at and be dominant in, and that really represents what we think of as a new kind of opportunity for us around more generically called business agility. We're strong in scaling up software operations, we're strong in helping bring software and software service or software system capabilities to market, we want to help companies more generically operating in a very agile way and deliver products and valuable features to the market. So, we want to pay attention to those guys.

On the low end, as we've talked about in the past, we still principally see two lower end competitors, and one is Atlassian, and we've talked about that at some length. I would say, we continue to treat and work with them much more as a partner. Remember our strategy is to build program and portfolio capabilities that allow folks to scale. I think that will continue to be an area where it would be very difficult and perhaps unprofitable given their business model to try to compete with us. VersionOne is another company we compete with and we see them having a much more similar footprint, and we're going to be more competitive with them in the future.

Alex Zukin - Stephens Inc.

Understood. And is there any increase in pressure on pricing or any disruptive pricing that either those two private vendors or legacy vendors are offering that is making it more difficult to invade the high proposition in terms of that new accounts?

Tim Miller

I don't believe there's been any change in pricing from either of those folks, although you might expect something from us given all the new capabilities that we have. We're right in the middle of making some of those decisions that we're testing out here at our annual user conference next week and expect us to make some noise about that in the next month or two.

Alex Zukin - Stephens Inc.

Understood. And then, Jim, if you look at the renewal rates, they have continued to come down. I think this is the fifth quarter with the declining renewal rates. What is a comfortable level that you think where they will normalize or should we continue to expect them – should we expect them to rebound later in the year as this renewal team gets more traction?

Jim Lejeal

I think you can expect improvement. We're not going to guide here, we haven't and we don't. But I do expect improvement over time. Realize we're disciplined about the cohort, and so a non-renewal we factor in the equation for the 12 month period, that's relevant. And in a way, now that the seat count size is getting larger, there's a side-effect of the large number and to move the percentage of renewal rate meaningfully for the better, it will take some effort.

But clearly the investment in the renewal team is intended to help this, as is the higher order discipline that Dan has put in place with the territories putting in place account plans. The idea is that you don't just land the customer, you touch them through their course of life and make sure that their agile transformation is successful, and that comes from meeting with your customer on a regular basis, and all of that activity is designed to better renewal performance.

Alex Zukin - Stephens Inc.

Understood. And the last one for me, is there any solid metric that you guys can point to, to reassure kind of investor sentiment about the overall market opportunity that you're addressing and the continued ability to grow that market opportunity?

Jim Lejeal

Your question Alex is, is there a metric I can point to the market opportunity? And so, I guess – I'm thinking about the question you are asking me and the best way to answer it. IDC has recently published a Agile Application Life-Cycle Management market study. We participated in that, in that we were a sponsor of the report. It calls out a significant CAGR growth rate associated with Agile in the transportation. And I think if you attend our conference next week, you're going to see a lot of activity, not just from customers, decision makers that are customers but decision-makers at many of our prospects. It's a rare thing to find a company now that's keen on innovation in their product cycle going back to waterfall. Agile is here to stay and we're the leader in that marketplace.

Alex Zukin - Stephens Inc.

Got it. Thanks guys.

Operator

And our final question comes from Richard Baldry from ROTH Capital Partners. Please go ahead with your question.

Richard Baldry - ROTH Capital Partners

Just a brief one. When you look at your [indiscernible] sales rep headcount, can you talk about the stability within that headcount, whether there are increased churn, particularly with say your more established players, have you added a lot more heads and put them into the territories or is it really just a matter of the newer heads not ramping as quickly [inaudible]?

Tim Miller

Tim here. So historically, our sales turnover has been low, some might say too low. With the changes that we've made, we've clearly had some increased turnover. We think that turnover is generally right, but we plan to monitor closely.

Operator

We do have an additional question from Peter Lowry from JMP Securities.

Patrick Walravens - JMP Securities

Actually it's Pat. So you guys previously, you were talking about 25% growth this year then maybe accelerating that in the future. How should we think about how fast this business can grow if things start working the way you'd like it to?

Jim Lejeal

Pat, generally I think the growth rate should accelerate and that's the framework of the business. Clearly we've made the investment, clearly we're in the early phase of the ramp for the headcount that we've added, and the second half of the year should show the signals that lay the foundation for accelerating growth in FY '16.

Patrick Walravens - JMP Securities

Are you now linking it to a number anywhere?

Jim Lejeal

Pat, I think at this point let us get through Q2. To set a number I think at this point is –it's a careful thing, right. We've just revised guidance in a way that's thoughtful. Allow us to get to the midpoint of the year and thing through and then set a stage for how we think the business can grow. Clearly we believe that we are better than a 25% grow and that's the way we've invested.

Patrick Walravens - JMP Securities

Okay. And then just one follow-up. I mean is it reasonable for me to take the $2.1 million from that big contract and add it to the $19 million of adjusted billings to get a sense for what the growth sets up?

Jim Lejeal

Yes, that's what you would do, Pat, that's exactly right.

Operator

And we've reached the end of the allotted time for today's question-and-answer session. I'd like to turn the conference call back over for any closing remarks.

Tim Miller

First of all, thank you everyone. If you're attending RallyON next week, we hope to see you there. Thank you.

Operator

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your telephone lines.

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Source: Rally Software Development's (RALY) CEO Tim Miller on Q1 2015 Results - Earnings Call Transcript

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