Dennis Story – SVP and CFO
Pete Sinisgalli – President and CEO
Terry Tillman – Raymond James
Mark Schappel – The Benchmark Company
Brad Reback – Oppenheimer
Manhattan Associates, Inc. (MANH) Q3 2010 Earnings Call Transcript October 19, 2010 4:30 PM ET
Good afternoon. My name is Christopher and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Manhattan Associates third quarter 2010 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. (Operator instructions) As a reminder, ladies and gentlemen, this call is being recorded today, October 19th, 2010.
I would now like to introduce Dennis Story of Manhattan Associates. Mr. Story, you may begin your conference.
Thank you, Christopher, and good afternoon, everyone. Welcome to Manhattan Associates 2010 third quarter earnings call. I will review our cautionary language and then turn the call over to Pete Sinisgalli, our CEO.
During this call, including the question-and-answer session, we may make forward-looking statements regarding future events or future financial performance of Manhattan Associates. You are cautioned that these forward-looking statements involve risk and uncertainties, are not guarantees of future performance, and that actual results may differ materially from those in our forward-looking statements.
I refer you to the reports Manhattan Associates files with the SEC for important factors that could cause actual results to differ materially from those in our projections, particularly our Annual Report on Form 10-K for fiscal 2009 and the Risk Factor discussion in that report. We are under no obligation to update these statements.
In addition, our comments will cover certain non-GAAP financial measures. These measures are not in accordance with or an alternative for GAAP, and may be different from non-GAAP measures used by other companies. We believe that this presentation of certain non-GAAP measures facilitates investors’ understanding of our historical operating trends with useful insight into our profitability, exclusive of unusual adjustments.
Our Form 8-K filed today with the SEC and available from our website manh.com contains important disclosure about our use of non-GAAP measures. In addition, our earnings release filed with the Form 8-K reconciles our non-GAAP measures to the most directly comparable GAAP measures.
Now, I will turn the call over to Pete.
Thanks and welcome to our third quarter earnings call. I'll start by reviewing highlights from the quarter. Dennis will then get into the details of our financial results. I'll follow with additional details about our business. And then, we'll move to questions.
As noted in our press release, we posted solid financial results in our third quarter of 2010. We recorded license revenue in the quarter of a little more than $12 million, up about 6% versus last year. As you know, Q3 has historically been our lowest license fee quarter and we expect that to be the case once again this year.
For the quarter, we recognized two million-plus-dollar license revenue deals. One was in the Americas with an existing retail customer where we expanded our warehouse management relationship by adding labor management and slotting optimization. The other was in Europe with a new customer for distribution management.
In addition to these two large deals, we closed another million-plus license deal, but will delay recognizing license revenue to future periods. This new client is a very large global information technology provider and one of the very few that offers to the market a highly regarded technology platform.
As part of our contract, we agreed to certify our solutions on that client's technology platform, which we have done in the past for other clients. However, since we've contracted to certify our solutions on this technology, for each of the next five years we will recognize the license revenue ratably over the term of the contract, beginning with our delivery of certified software to the client in Q1 of 2011.
Although we aren't recording license revenue in this quarter from this contract, it is a very important win for Manhattan. The client has made many acquisitions over the past few years and as a result, already owns supply chain technology from SAP, Oracle, RedPrairie and others, though not Manhattan. Nonetheless, after careful evaluation, our superior solutions won.
In addition to a large license fee, our professional services teams will be assisting this client with a multiyear global deployment of warehouse management, extended enterprise management, distributed order management and other solutions. Our SCOPE solution suite and our platform strategy played very well with this client.
Overall, our platform strategy continues to resonate very well in the market. That's illustrated by our strong competitive win rate in the quarter of about two wins out of every three potential deals versus our major competitors. Importantly, we are winning the large strategic deals. Our implementations of warehouse management on our platform continue to progress well and I'll comment more about that following Dennis' remarks.
Year-to-date, license revenue has more than doubled since last year. Overall, revenue growth is 22% and adjusted earnings per share of $1.06 is greater than full year 2009 and up 63% versus last year. We expect Q4 to be another successful quarter for us.
Dennis will now provide some details.
Thanks, Pete. Manhattan delivered another strong quarter of financial results, marking our third consecutive quarter of double-digit revenue growth, delivering $74 million in total revenue and $0.32 in adjusted earnings per share, setting a pace to exit 2010 achieving a solid rebound year, off an aberrant 2009 comparison.
Revenue comps in the second half are definitely firming up as the business returns to more typical seasonality on revenues and barring another macroeconomic catastrophe, expense comps will largely normalize in 2011 versus 2010 as we look to pose back-to-back revenue and earnings growth years.
Highlights for the third quarter are one, license revenue of $12.1 million increased 6%. Business activity and visibility continues to normalize as we close three million-dollar-plus deals, only two of which are reflected in this quarter's license revenue. Two, services revenue increased 14% year-over-year, led by 23% growth in consulting revenue as positive license performance over the past five quarters is driving current growth. In fact, we are actively recruiting as services demand continues to exceed capacity.
Three, adjusted earnings per share of $0.32 was down from $0.43 in 2009. However, on an apples-to-apples basis, adjusting for the impact of 2009 short-term compensation reduction measures that were restored in 2010 combined with lower 2009 performance based compensation and income tax expense, all of these which totaled about $0.20 of EPS, EPS grew nearly 39%.
We all know 2009 was a tough year. So the point of this comparison is simply to be clear that the core underlying fundamentals of the business are strong and delivering great financial leverage.
Four, we continue to maintain our meaningful strategic investments in R&D, investing $0.13 of every revenue dollar to deliver competitively superior solutions. Five, operating cash flow continues to be strong, delivering $11.5 million in the quarter and $35 million year-to-date. And finally, our balance sheet strength continues to support long-term strategic flexibility with cash and investments totaling $117 million and a consistently efficient and well-managed capital structure. Having no need to service debt and backed by strong operating cash flow, we repurchased $15.4 million in common stock during Q3.
That covers the key highlights. On to the details. Q3 total revenue performance of $74 million increased 13% over the prior-year quarter on the strength of growth across all revenue lines, license, services, and hardware.
Our Americas segment continued its momentum, posting its third consecutive quarter of double-digit revenue growth of 13% despite the deferral of a license deal worth more than $1 million. Internationally, Europe total revenue of $8.3 million for the quarter increased 27% over Q3 2009 and APAC revenue of $3.2 million was up 2% over 2009. Americas continues to pave the way as Europe's economic recovery, particularly in the U.K., lags the U.S.; and APAC, while strategic, is much smaller by comparison with sales that are characteristically lumpy.
For Q4, we expect to deliver total revenue of $74 million to $75 million. We expect our revenue mix to be in line with our historical revenue pattern, reflecting higher license revenue in Q2 and Q4, with Q4 total revenue exhibiting a partial offset from lower services revenue, driven by the Q4 seasonal holiday period. Achieving this level will result in 2010 full year total revenue of about $300 million or 22% growth over 2009 total revenue of $247 million.
For license revenue, in the quarter, Americas, excluding the large deal deferral Pete mentioned, recognized $10 million in Q3 license revenue, essentially flat with Q3 of 2009. Europe's Q2 license revenue totaled $1.7 million, which is up from $464,000 delivered in Q3 of 2009 and includes one software license deal with the value exceeding $1 million. And finally, our APAC team delivered license revenue totaling $363,000, down from $553,000 in Q3 of 2009.
Services revenue of $53.5 million in the quarter increased 14% compared to Q3 2009. Our consulting services revenue continued to experience solid demand with revenues of $33.3 million increasing 23% over Q3 2009 and down modestly on a sequential basis to Q2 2010, primarily due to summer vacations.
Maintenance revenue totaled $20.1 million, increasing 2% over the prior year, while flat sequentially due to timing of cash collections. We recognize maintenance renewal revenue on a cash basis, so the timing of cash collections can cause inter-period lumpiness. Retention rates continue to track in the 90-plus-percent range, while year-to-date revenues have grown 6%.
Looking at Q4, we expect services revenue to be down sequentially from Q3 in a range of 2% to 4% due to the seasonal holiday period. You may recall, our sequential decline from Q3 to Q4 in 2009 was 9% and in 2008, it was 10%.
Consolidated services margins continue to be strong as we posted 54.1% for the quarter compared to 54.8% in Q2 2010 and 58.3% in Q3 2009. As you know, the year-over-year comp is not meaningful due to the macroeconomic dislocation. Sequentially, margins are down over Q2 2010 on the combination of hiring to fulfill demand and summer vacations. We expect Q4 services margins to be in the 50% to 51% range due to the seasonal holiday impact on revenue, while full year services margin should be in the 53% to 54% range.
Moving on to adjusted operating income, Q3 adjusted operating income totaled $11 million with strong operating margin of 14.9%. Albeit strong in quarter margin, the year-over-year revenue and expense comparisons are masking core underlying operating margin leverage performance in the business. A better proxy is year-to-date operating margins, which for 2010 are 16.3% compared to 11.5% in 2009, 14.2% in 2008 and 14.8% in 2007 and 2007 was the strongest license revenue year in our history.
As you know, also in 2007, we introduced restricted stock as a component of our equity compensation. And in 2010, we eliminated stock option awards in favor of 100% restricted stock grants, of which 50% are service based and 50% are performance based. We consistently include – we have consistently included the expense of our restricted stock program and adjusted earnings and also have factored that expense into our annual margin expansion objectives, which is inconsistent with the practice of other software companies.
We researched the filings of 40 software companies, including all of our comp companies for our 10-K and proxy filings and confirmed that 39 out of 40 excluded all stock-based compensation, stock options, and restricted stock from adjusted earnings. Just in case you are wondering, number 40 was Microsoft who reports only GAAP earnings. Therefore, to provide you with a more meaningful software comp as a reference, we have added a detailed breakout of our restricted stock expense as item 10 to our supplemental schedule in today's earnings release.
Excluding restricted stock from our adjusted earnings for competitive comparability, our year-to-date 2010 adjusted operating margins are 18.4%. For context, 2009 was 12.8%, 2008 was 15.2%, and 2007 was 15.4%. Bottom line, the underlying core financial strength of the business is solid and we continue to focus on investing for growth, while achieving margin expansion.
Adjusted operating expenses, which includes sales and marketing, R&D, G&A, and depreciation, were $29.9 million for Q3 2010, increasing 17% over Q3 2009 due to an abnormal comp. As previously discussed, this increase was planned to absorb performance-based compensation, tied to improved results, restoration of normalized base compensation, following short-term reduction initiatives executed in 2009, and higher restricted stock expense associated with the change in our equity incentive program.
So from an operating margin perspective, based on expected seasonality in services revenue in Q4, our Q4 operating margin goal is to deliver 13.5% to 14.5% margins and to close out the full year with operating margins in the 15.5% to 16% range, representing a 210 to 260 basis point improvement over 2009 this raises the top end of our operating range by 150 basis points above the range discussed in our Q1 earnings call, reflecting a solid rebound from 2009.
In other income and expense, we reported Q3 other expense of $187,000 compared to Q3 2009 other income of $255,000. For your reference, as part of our supplemental disclosure, we have added a breakout detailing the other income expense components under item number six.
Regarding income tax expense, our adjusted effective tax rate for the quarter was 34.05%, down slightly from 34.5% in the first half due to our 2009 tax return filing accrual true-up. We expect Q4 to be approximately 34.5%.
Transitioning to diluted shares, for the quarter, diluted shares totaled 22.1 million shares, down from 22.8 million shares in Q2 2010, on share repurchases and lower common stock equivalents. During the quarter, we repurchased 573,000 shares of Manhattan common stock at an average share price of $26.96, totaling $15.4 million. As noted in today's earnings release, this month our board approved raising our share repurchase authority limit to a total of $25 million.
For Q4 2010, based on current stock price appreciation, we expect diluted shares to average about 22.5 million shares, which does not assume any common stock repurchases. These estimates depend on a number of variables such as stock price, option exercises, forfeitures, and share repurchases, which can significantly impact our estimates.
So, on a GAAP basis, we reported GAAP diluted earnings per share of $0.28 for Q3 compared to $0.50 in Q3 of 2009. Consistent with adjusted earnings, GAAP diluted earnings in 2010 versus 2009 represent an abnormal comp. In addition, Q3 2009 includes $0.12 of EPS benefit from a reduction in tax reserves associated with expiring tax audit statutes. A detailed description of GAAP to non-GAAP adjustments can be found in the supplemental schedule, reconciling selected GAAP to non-GAAP measures in our earnings release today.
Moving on to cash flow and balance sheet metrics, for the quarter, we delivered cash flow from operations of $11.5 million, bringing our year-to-date total to $35 million, down about $3.5 million over year-to-date 2009, primarily driven by working capital build and trade receivables.
Our accounts receivable balance has increased about $10.5 million from December 2009 on license and services revenue growth. Our DSOs continue to be solid at 60 days compared to Q2 DSO of 55 days.
Capital expenditures were $1.6 million in the quarter and $4.3 million year-to-date. For 2010, we estimate capital expenditures to be about $6 million to $7 million.
Our cash and investments at September 30, 2010 totaled $117 million compared to June 30, 2010 cash of $120 million. Cash is down slightly on investments in CapEx and share repurchases.
Overall, our forecasted 2010 full year adjusted results project a solid year versus 2009 with total revenue of about $300 million versus $247 million in 2009, an increase of about 22% which should derive adjusted earnings per share growth of about 40% to 44% over the $0.96 per share we delivered in full year 2009.
Now, that covers Q3 and 2010. But before I turn the call back to Pete, we are in the early stages of our 2011 budgeting cycle and there are a few broad elements whose impact on EPS should be considered for modeling.
Revenue, we are assuming no – assuming no macroeconomic backslide, we plan to grow total revenue at roughly 2x the market growth rate of 5%. Margins, we continue to focus on expanding operating margin and are targeting a minimum 100-basis point improvement over 2009. On the tax rate, we are currently estimating our effective tax rate to rise to about 36% as our India tax holiday expires in March of 2011 and U.S. state income tax expense increases. And diluted shares, we are currently forecasting 23 million per quarter.
Overall, we believe 2011 will be another positive year of revenue and adjusted earnings per share growth with positive margin expansion. We will provide more details on our Q4 earnings call.
So now, I'll turn the call back to Pete for the business update.
Thanks, Dennis. Here are some of the business highlights of the quarter. We added many new customers and expanded relationships with many existing customers across all regions during the quarter. A list of those that have agreed to allow us to use their names is included in our press release.
As I mentioned in my opening comments, we closed three million-plus-dollar deals in the quarter, two of which had recognized license revenue in the quarter. The retail, consumer goods, and logistics service provider verticals were once again strong contributors to our license fees. And together, these sectors represented more than half of license revenue in the quarter.
About 75% of the quarter's license revenue was from existing customers and about 25% from new customers. About 60% of the quarter's license revenue was for warehouse management solutions and about 40% for our other supply chain solutions.
We continue to drive customer satisfaction across the globe. And in Q3, our professional services teams helped take about 100 sites live with our solutions. Today, we have two client sites live with our platform based warehouse management solution and about a dozen more in various stages of implementation. These implementations continue to progress well.
I believe our relative competitive position has never been stronger. The primary way we strengthened our position and will continue to improve it is through important investments in our products, our technology, and our people. We continue to make significant investments in research and development. One-third of our global staff is in R&D. In Q3, R&D accounted for about 13% of our total revenue. That is down a bit from our historic level and we expect to remain at about that level going forward.
At the end of September, we had about 1,900 employees around the world. That's an increase of about 50 since last quarter, essentially all in billable professional services positions. We have 68 people in sales and sales management with 58 of those sales reps. We have one fewer rep and one fewer sales manager than a quarter ago. We hope to add about 100 positions in the near term to fulfill existing customer demand for professional services.
Last week, we completed our European customer conferences. We started October 5th in France, progressed to the U.K. on October 7th, and finished in Holland on October 12th. Attendance was good at all three conferences and the mood was quite positive. While we expect the economies in Europe to continue to struggle, particularly the U.K., we are encouraged by our customers' enthusiasm about our solutions and our partnerships with them.
As Dennis mentioned, looking at Q4, we expect another solid quarter of financial results. And as we look to 2011, we are excited about our strong competitive position and our momentum. Barring another economic crisis, we expect 2011 to be a good year for Manhattan Associates. And as Dennis mentioned, we will share our thoughts about 2011 during our Q4 earnings call in early 2011.
Operator, we will now take questions.
(Operator instructions) We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Terry Tillman from Raymond James. Your line is now open.
Terry Tillman – Raymond James
Yes, good afternoon, guys. Thanks for the time for my questions. I guess, Pete, first question just relates to – you all have emphasized several times this large deal. It sounds like maybe it's kind of a milestone deal.
If I'm on the right path, I mean, can you give us a little bit more color – I mean, because you do sign million-dollar deals every quarter and sometimes they are just a little over a million. I know you can't give any real exact detail, but is this a multi-million dollar type license transaction first of all? And second of all, do we at least see some service revenue into the fourth quarter? And then, how do we think about the license revenue being recognized ratably over the next year or so?
Yes, sure, Terry. I will share with you what we can. As you can imagine, in most of our contracts, we agree to a reasonable level of confidentiality for our clients. So I'll share with you what I think is appropriate. It was a large deal for us, was above $1 million. I can't give you anything more specific than that, but they were quite excited about that. And as I mentioned in my prepared remarks, we are also quite excited about the services opportunity for us over the next couple of years, helping roll out solutions globally for that large client, quite excited about it.
One of the reasons why we did raise this in the call, strategically a very important win for us, competitively very important win for us. In addition though, I think this sales cycle was a well publicized sales cycle. Several of you that are on the call had heard about it and had asked us about it in the past. And in the spirit of full disclosure and transparency, we thought it was important since some of the folks on the call were aware of the deal that we shared that with everyone. So it is a large deal strategically and competitively very important that that should have very positive economic benefits for Manhattan beginning in 2011. We don't expect to see services revenue of any proportion until 2011.
Terry Tillman – Raymond James
Okay. And Pete, I guess as a follow-up on the license business, let's exclude this – kind of this situation. How was that kind of meat-and-potatoes business, the mid-6 figure deals? Last quarter, you talked about seeing a broadening of recovery to maybe more Tier 2 type opportunities. I didn't hear anything on the call. I mean, can you give us sense on how the broader business did per your expectations on the license side?
Yes. Overall, Terry, we were quite pleased with the quarter, the activity level, what closed, the size of deals, and the mix of deals, verticals, geography. As you – I think you well know, Q3 has historically been our lowest license revenue quarter and that will play out that way I believe for 2010. But overall, we were pleased, the activity level is good in all three regions, the type of business we are talking about is quite attractive. As I mentioned in my prepared remarks, we are quite pleased with our competitive win rate. We believe that the strategic deals are coming to Manhattan Associates and we expect that to continue.
Having said that, certainly the economy is still difficult, sales cycles are longer than they were several years ago and we expect that continue to be lengthened beyond what we had gotten used to in the mid part of this decade, so things are back to the way clients had purchased software a coupe of year ago. But having said that, in this environment, we are quite pleased with the results, the size of the pipeline, the activity of our sales team, and the momentum we have built with our new suite of solutions. So we feel very good about the quarter and the prospects looking at Q4 and 2011.
Terry Tillman – Raymond James
Yes. And thank you on that. And I guess the last question, I can't help it, Dennis – I mean, you broached the subject of 2011. You are talking about the idea of restricted stock and because you don't exclude that, I mean it's a material impact I guess to what your margins otherwise would be relative to all of your peer group. Is there any thought at a point that maybe after fourth quarter and we get into next year and if you give any kind of guidance like you did this year for EPS, why not start to give EPS guidance that excludes the impact of restricted stock if it's so much different and would be more in line with the others? Thank you, guys.
Yes. We are not taking any option off the table at this stage, Terry. But it's early in terms of deciding how we are going to go with guidance for 2011.
It's a great question though, Terry. Thanks.
Your next question comes from the line of Mark Schappel from The Benchmark Company. Your line is now open.
Mark Schappel – The Benchmark Company
Hi, good evening. Pete, during the past few quarters or so, your order lifecycle management solutions have been playing an increasing role in your product and your sales line. I'm just curious how they did this quarter and whether they played a role in the large deal that came through.
Great question, Mark. We have been pleased with the momentum we are building in order cycle management. We think we have got a unique value proposition for the marketplace and in particular for companies that have multi-channel operations that are trying to more efficiency serve those channels without building up excess inventories or multiple inventories.
I'm pretty sure I mentioned in my prepared remarks that one of the solutions we did sell to that deal that was closed in the quarter but not recognized included order lifecycle management. We think that was one of the solutions that differentiated us from our competitors and we think that was one of the important factors that allowed us to win that deal.
So we are pleased about that and we continue to make good progress with that solution as a differentiator in the market space. Again, we think the market is looking for ways to improve efficiency and drive inventory out of the supply chain, while maintaining or improving customer satisfaction and we think our order lifecycle management solution is a big participant in that direction.
Mark Schappel – The Benchmark Company
Okay, thanks. And I was wondering, Pete, if you could just give us your thoughts on what you are seeing as far as customer interest on – with respect to on-demand warehouse management and transportation planning solutions. As you know, one of your competitors purchased a small cloud-based WMS vendor, I think it was in the spring. I was wondering if you are seeing any customer interest there.
Yes, Mark, we have been quite active in Software as a Service for several years. I know you know about eight or so years ago, we acquired a company, Logistics.com was its name at that time that offered Software as a Service for transportation solutions. We have added to that modestly with a few clients in inventory optimization Software as a Service and have been working closely with our customers and prospects trying to gauge the market's appetite for SaaS solutions.
Clearly, we believe we are well positioned if the market has an appetite for SaaS solutions to be able to provide that as we have done that for now approaching a decade. We have not seen though in our target market. So our target market is larger companies that have complex supply chain challenges. We have not seen an appetite for distribution management as a software as a solution shared environment offering. I believe that probably will have appeal to very small companies and I think that could be a useful solution to those small companies, but that's a very different business model than business model that Manhattan is in.
Our target market is Tier 3, 2, and 1, the larger organizations with complex supply chain needs. And at this point, it's been clear feedback to us that they are looking for packaged application software with sophisticated functionality that can help them optimize their supply chains and at least at this point aren’t looking for that in a multi-tenant Software as a Service environment where they might give up ability to package that solution to best meet their needs.
But as I said, we have quite a bit of experience in that space and if that market begins to move in that direction, we believe we are well prepared to do that. But frankly, we don't believe we are going to see a lot of appetite from larger companies for that, particularly in distribution management.
Mark Schappel – The Benchmark Company
(Operator instructions) Your next question comes from the line of Brad Reback from Oppenheimer. Your line is now open.
Brad Reback – Oppenheimer
Hi guys, how are you?
Brad Reback – Oppenheimer
So Pete and Dennis, on this really big deal in the tech sector that you signed, you talked about a significant amount of services going forward. Given the base load that will give your service organizations, should that enable you to take a step function up in margins – gross margins in that business going forward or should we still think about that as where it's been historically?
I would – for planning purposes, Brad, I would say it's probably going to be in line with what we have done historically. We had a bit of a shortage in 2010 of staff. So our staff has worked especially hard in 2010 to try to meet customer expectations, customer needs, and so forth. And as we have said on a couple of calls, we are trying to add more people to our services team to improve the sustainability of our position and to ensure customer satisfaction.
So I think Dennis had in his comments what to expect for Q4. I would expect for planning purposes margin success in line with what we have recently achieved would be reasonable.
Now, I do want point out that those margins are the best in the world for professional services organizations. We are quite proud of the gross margins we are able to drive in our services business and very excited about being able to maintain that going forward on a larger revenue base. But I do think given the large deal that we've signed and the tail of services that will have that will certainly add to the revenue outlook for that business. But I forecast the margin on that in line with our recent experience.
Brad Reback – Oppenheimer
Thanks a lot.
Good. Thank you, Brad.
There are no further questions at this time.
Very good. Well, I would like to thank everyone for joining us for the call and we look forward to speaking with again in about 90 days. Have a good night.
Ladies and gentlemen, this concludes today's conference call. You may now disconnect.
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