Lawson Software CEO Discusses F2Q2011 Results – Earnings Call Transcript

Jan. 6.11 | About: Lawson Software, (LWSN)

Lawson Software Inc. (NASDAQ:LWSN)

F2Q2011 Earnings Call Transcript

January 6, 2011 5:00 pm ET

Executives

Barbara Doyle – VP, IR

Harry Debes – President and CEO

Stefan Schulz – SVP and CFO

Analysts

Mark Murphy – Piper Jaffray

Stan Zlotsky – Deutsche Bank

Richard Williams – Cross Research

Ajay Kasargod – Morgan Keegan

Steve Koenig – Longbow Research

Peter Goldmacher – Cowen & Co.

Brad Sills – Barclays Capital

Mark Schappel – Benchmark

Neil Herman – Soleil Securities

Brian Murphy – Sidoti & Co.

Operator

Welcome and thank you for standing by. At this time all participants are in a listen-only mode until today's question-and-answer session. (Operator instructions) Today's call is being recorded. If you have any objections, you may disconnect at this time.

I'd now like to turn today's call over to Barbara Doyle. Ma'am, you may begin.

Barbara Doyle

Thank you, operator, and good afternoon to everyone on the call. This is Lawson Software's fiscal 2011 second quarter conference call. It covers performance for the quarter ended November 30, 2010.

With me on today's call are Harry Debes, Lawson's President and Chief Executive Officer; and Stefan Schulz, Senior Vice President and Chief Financial Officer. After completing our prepared remarks, we will take your questions as the operator described.

Before we begin the call, please let me review our Safe Harbor statement. We remind you that this call will include forward-looking statements which are subject to risks and uncertainties. These forward-looking statements contain statements of intent, belief or current expectations of Lawson Software and its management.

Such forward-looking statements are not guarantees of future results and involve risks and uncertainties that may cause actual results to differ materially from the potential results discussed. Our SEC filings contain further information about risk factors that could cause actual results to differ from management's expectation. We do not obligate ourselves to update our forward-looking statements for circumstances or events that occur in the future.

Please let me also remind you that in addition to reporting financial results in accordance with Generally Accepted Accounting Principles, Lawson Software reports non-GAAP financial results. Our remarks today will focus on our non-GAAP results unless otherwise noted. Discussion of our use of non-GAAP results, as well as a detailed reconciliation to our GAAP results is included in our press release. We also have a supplemental summary of our historical key business metrics, on our website at www.lawson.com/investor for your reference.

With that, let me turn the call over to Harry Debes.

Harry Debes

Thank you, Barbara and good afternoon everyone. As usual, I'll begin today's call by commenting on the overall business in sales performance in our second quarter. Our CFO, Stefan Schulz will cover our financial results in more detail and update our financial guidance. I'll wrap up the call with some closing comments and then, we'll take your questions. So, let's begin.

Our bottom line performance in Q2 was very good. Non-GAAP earnings per share of $0.12 increased from $0.09 in the second quarter of last year. Operating margin of 17% also improved from 14% last year, driven by improvements in our M3 Business. Increasing M3 profitability is one of our top priorities for fiscal 2011. So, we're very pleased to see this progress.

Overall, when it comes to our bottom line, I'm pleased with our trend of steady and consistent improvement in profitability. Revenue performance was mixed. Total non-GAAP revenues were $189 million and that's a 2% year-over-year increase. Total software contracting in the quarter was 26 million and that's up sequentially from $21 million in Q1, but down slightly from $27 million in Q2 of last year.

Software contracting for the first half of 2011 was $47 million, up 5% compared to the first half of last year. Software contracting was very strong in our S3 Business, but weak in one of our business, M3 businesses and this led to a year-over-year decline in license revenue. I'll explain this in greater detail, when I discuss the M3 Business in a few minutes.

Maintenance revenues for the Company were strong and grew 16% year-over-year. Consulting was down 10% as we forecasted. We've been downsizing our services business, so this is on track with our strategic plans for services. Now, let me give you some additional color by business segment starting with S3.

Our S3 segment performed very well, with license revenues up 25% compared to the second quarter of last year. 11 of our 13 largest deals in the quarter were S3 deals, and all three S3 business units showed year-over-year growth in software contracting.

Healthcare continues to be our strongest business as we bring more products and more expertise's to customers in this vertical. Healthcare software contracting and license revenue both increased year-over-year. Contracting more than doubled year-over-year, and Healthvision accounted, for about half of that increase. As we said when we announced the acquisition, we expected Healthvision would make a strong contribution to our business and this is proving to be the case.

In Q2, Clover Leaf was the top selling product in the healthcare vertical and our largest deal in the quarter for the entire company was the Cloverleaf sale to Alberta Health Services in Canada. This is a loss on many suite customers who added the Cloverleaf Integration Suite, and this deal exceeded $1 million of licensed software. Our healthcare pipeline continues to grow. Sales activity is up, and we feel very good about the market leadership and growth potential in this business vertical.

S3 public sector license revenues also increased compared to Q2 of last year. We had several key public sector wins in the quarter. Denver Public Schools, Tacoma Public Schools, and the State of Arizona purchased Lawson Talent Management. The City of Boise and the City of Lee's Summit, Missouri purchased our four ERP suites.

We also signed a significant cloud services deal in public sector with Scott County here in Minnesota. There had been a loss in customer for three years and in 2009 began using our Amazon Cloud Disaster Recovery Service. Based on that experience in November, Scott County signed a three year $600,000 agreement with Lawson to also move their financials, procurement and HR production environment to our cloud offering.

Overall, we continue to see good public sector opportunities with schools districts, city and county governments. Our software help these entities improve efficiency and reduce cost as they face budget and funding pressures. In addition, focus on feature effectiveness is driving increased interest in our talent management product in the K-12 markets. S3 service industries contracting also grew in the quarter driven by sales of our Human Capital Management Solutions.

Our HCM business is gaining considerable traction with strong sales growth in all three of our S3 verticals. In particular, sales of our new talent management products are growing rapidly. We've tripled the number of customer sales in the first half of this year compared to last year, and we now have 45 customers signed to Lawson Talent Management. We believe more growth potential exists for our HCM solution.

Our initial sales focus was on our installed base of customers, where we've had great success, but we're confident that there is also considerable potential outside the traditional loss in customer base and for this reason we've recently created a sales unit which focuses only on new HCM customer opportunities.

We've already had some early success and the pipeline and opportunities already identified are considerable. The compelling HCM market opportunity and the strong strategic fit was a catalyst for our acquisition of Enwisen, which closed on December 31st. They were already a strategic partner and during that time we became very familiar with their products and the market opportunity.

Enwisen's HR knowledge base portal, HR call center, on-boarding, off-boarding and Total Rewards product help companies improve the delivery of their HR services, while reducing employer costs. They already have 250 customers and are considered to be the leaders in HR service delivery space. They represented a great complement to our HCM suite, and with Enwisen we now have the broadest set of human capital management solutions available in the market.

So, in summary, our S3 business continues to perform very well. Operating margins was healthy at 24%. Revenues grew organically as well as through synergies from the Healthvision acquisition. Enwisen now strengthens our position in HCM and will drive further growth in this segment.

Now, let's discuss our M3 business. Our focus in fiscal 2011 is to make this business more profitable. On that measure, we are succeeding. M3 operating margin increased to 7% in Q2, and that's a significant improvement from the losses we experienced in the past and even from this 3% margin in our first quarter. But with our focus on the bottom line, M3 license revenues fell 30% from Q2 of last year and contracting declined 40%, and now let me put this into perspective.

The decline in M3 in this quarter was driven by our Equipment Service Management & Rental business. Last year, ESM&R our sales activity was very robust following the launch of our new solution in November of 2008, and in Q2 of last year, we signed a very large multi-million dollar ESM&R contract. That deal size is very unusual for us and we didn't have the contract of similar size. So, the comparison really stands out.

At this stage, we are in the implementation mode for the first wave of ESM&R sales that we made last year. Once these new customers are live, we can use their successes to support new sales, and by the way, we expect those consumers to all go live in calendar 2011. While it's frustrating for us to go through such sales peaks and valleys it's not unusual when you're developing a new market, but here's the bottom line.

While ESM&R sales activity has slowed, no one who should misconstrue our long-term opportunity in this market, it is substantial and we are fully committed to realize that potential. I continue to believe that ESM&R will be a major contributor to Lawson's growth. Q2 was disappointing, but expect contracting and license revenue to be much better in the future. So, that was the only really bad news.

Other portions of our M3 Business have actually performed very well for the first six months of this year. M3 consumer products which includes food and fashion customers, continues to show increasing pipeline and sales activity. Consumer products had the highest level of sales activity in M3 in the quarter, including 71 license transactions. Customers are again looking at improving supply chain and inventory management tools as levers to drive efficiencies that are critical to their profitability.

As a result, we've also seen improving traction in this vertical upgrades to our new M3 version 10.1 release, as well as add-on sales across a wide range of our products including Smart Office, Lawson Fashion Product Lifecycle Management, Demand Planning, Supply Chain Planning and Warehouse Mobility. Finally, M3 maintenance revenue also increased year-over-year and we have great hopes for that going forward.

So, that concludes my opening remarks regarding the revenue and now, I'll hand over the call to our CFO, Stefan Schulz.

Stefan Schulz

Thank you, Harry and good afternoon. I will review the financial highlights from our Q2 results and provide guidance for our third quarter, as well as our current view of full year of fiscal 2011 results. As a reminder my comments will reference our non-GAAP results.

As Harry discussed, we had strong bottom line performance in Q2. EPS of $0.12 was at the top end of our guidance range. Operating margin of 17% improved three percentage points making Q2 the ninth consecutive quarter we've shown a year-over-year operating margin increase.

Second quarter was highlighted by licensed contracting growth in several of our strategic vertical and solid margin improvement in our M3 Business. Contracting growth and margin improvement in M3 are our key priorities in fiscal 2011. While we haven't grown in all of our strategic verticals, we are pleased with the progress on these priorities in the first half of our fiscal 2011.

Let's look at our key financial metrics beginning with our P&L. Harry already covered license contracting and revenue, so I will start with maintenance revenue. Our maintenance revenue is up nearly $99 million increased 16% year-over-year. Maintenance continues to be an area of strength for Lawson.

Healthvision continues to be a strong contributor to our business and accounted for more than half of the year-over-year increase in maintenance revenues. But even without the impact of Healthvision, our organic maintenance revenues increased 7%.

On an organic basis, we continue to see the benefit from our strong Americas maintenance renewal cycle completed in Q1, as well as higher contracting through the first half of the year. With some additional collections completed in Q2, our renewal rate for Americas is now approaching 97%. This high renewal rate is solid proof of the strong value of our solutions and our world-class customer support.

We also had some additional win backs from customers who went off maintenance last year. In Q2, we had more than $1 million of catch up revenue that customers pay to reinstate their maintenance. We have seen win backs in the last three quarters, which certainly benefits our revenues. We hope to see more of these win backs in future quarters, but it is not something we can count on with the high degree of certainty.

Our renewal cycle for international customers is now underway and early indications are good. Given our engagement with customers and the win backs we have seen to-date, we expect to see improvement over the 2010 international renewal rate, which was approximately 90%. We will provide an update on this renewal cycle on our third quarter conference call.

Maintenance margin of nearly 83% improved 160 basis points year-over-year and was flat sequentially. Our maintenance business continues to be a very big part of our profitability improvements over the last nine quarters. Consulting revenues of $64 million were down 10% year-over-year consistent with our expectations communicated on our Q1 call.

We have recruited and enabled a global partner network, and they are now delivering more services to our customers. This allows us to provide more choices and resources to our customers, which in turn has allowed us to strategically shift our business model. Services as a percent of total revenue in Q2, was 34%, down from 38% last year. Looking ahead we expect our consulting business to stabilize around 30% to 35% of total revenues.

Q2 services margin was 14%, up from the seasonally low first quarter margin of 9% but down compared to the 17% reported last year due primarily to the revenue recognition timing on some large S3 services engagements. Our Q2 services margin was relatively in line with the 15% we said we were targeting to achieve this quarter.

As maintenance revenues have grown and service revenues have declined we've achieved a more favorable mix of total revenues in terms of our gross margin. This change in revenue mix has resulted in a gross margin of 61%, which is up 350 basis points from last year.

Moving down the P&L, our operating expenses were $83 million, up $3 million or 4% year-over-year. We continue to manage our operating expense as well even with the addition of the operating expenses from Healthvision. Our 17% margin reflects a 22% increase in operating income.

On a business unit level, S3 margin was 24% compared to 25% in Q2 of last year. S3 continues to be a strong and steady business for us. The M3 margin nearly doubled compared to last year and was 7% in Q2. The initiatives to improve the M3 margin that were put into place towards the end of last fiscal year are beginning to pay dividends for us, but there's still more work to do.

Now, I'll move on to some key balance sheet metrics and cash flow. Our balance sheet remains healthy with almost $300 million of cash in investments, and net cash of approximately $70 million as of November 30. With the recent announcement of the Enwisen acquisition, we used $70 million to close the transaction in December, but this will be offset with our seasonal increase of cash flow during the second half of fiscal 2011.

Total deferred revenues at the end of Q2 were $205 million, down from $273 million at the end of Q1. The sequential quarter decrease is typical for a Q2 because we renew our maintenance contracts with customers in the back half of the fiscal year. As a result, deferred maintenance revenues decreased in quarters one and two, and then, increase in quarters three and four. Compared to the prior year, total deferred revenues increased by $21 million, driven by the strong maintenance renewals we experienced in the 2010 America's renewal cycle.

Consistent with our historical seasonal trends, we reported a net use of cash from operations during the quarter. Cash used in operations was $50 million, compared to $32 billion in Q2 of fiscal 2010. The higher net use of cash this year was primarily driven by accelerated maintenance collections on our America's renewal cycle last year, which has the effect of lowering cash collections in the first half of this year.

Our use of cash through the first half of fiscal 2011 totaled $88 million, but we will more than make up this deficit in the second half of our fiscal year, as we collect international and America's maintenance renewals. We expect fiscal 2011 free cash flow to be between $120 million and $130 million which compares to our initial estimate of approximately $130 million.

This slight change is primarily the result of anticipated early settlements in some of our restructuring liabilities. There are no material changes in our expectations for EBITDA or the core working capital components of cash flow. DSOs were 52 days, which is consistent with Q1 and 7 days better than last year. We are pleased with the year-over-year improvement in DSO and we expect this improvement trend to continue for the second half of the year.

Finally, turning the guidance, GAAP revenues for Q3 of fiscal 2011 are expected to be $188 million to $193 million and we anticipate total non-GAAP revenues to be in the range of $190 million and $195 million. GAAP EPS in Q3 is expected to be in the range of $0.06 to $0.08 and non-GAAP EPS is expected to be in the range of $0.11 to $0.13.

I will note that the Enwisen transaction was completed on December 31. We do not expect the acquisition to have a major impact on our Q3 revenues however it will create slight dilutive pressure on earnings during the integration through the end of the fiscal year.

As a result we are reflecting a little wider range in our Q3 EPS guidance to account for the near-term effects on EPS. In fiscal 2012, we anticipate Enwisen will add $28 million to $30 million in subscription and services revenues. Subscription revenues are currently reported in our consulting services revenue line. For now, all of Enwisen's revenues will fall in that line on our financial statements. Enwisen should add approximately $0.02 of EPS in fiscal 2012.

Our guidance includes an estimated non-GAAP tax rate of 35% which we will apply consistently in each quarter in 2011. Our Q3 guidance also assumes currency exchange rates based on average rates during December.

Looking ahead to our full fiscal year results, our view of full year results remained in line with our initial guidance, although we feel we can tighten the range a bit and reflect some revenue upside for the Enwisen acquisition. We anticipate GAAP revenues will be in the range of $764 million to $774 million and non-GAAP revenues are estimated at $770 million to $780 million. GAAP EPS is expected to be $0.28 to $0.30 and given our estimated range of results for non-GAAP EPS provided in the press release, we are comfortable with the analyst current full year estimates averaging $0.50 per share.

Our full year guidance uses actual currency results for the first half of the year and assumes currency exchange rates based on average rates during December for the remainder of the year. The detailed reconciliation and explanations between GAAP and non-GAAP results are located in our press release and is available on our website at www.lawson.com/investor.

That concludes my comments, so I will turn the call back to Harry.

Harry Debes

Thank you, Stefan. Overall, Q2 was a very good quarter for the bottom line and continues our trend of consistent operating performance. We are pleased with the revenue growth in S3 and with the profit improvement in our M3 business.

So, the three key takeaways from Q2 are; first, our S3 performance continues to be strong anchored by healthcare; second, we continue to build our strength in Human Capital Management with investment in sales, marketing and the key acquisition of Enwisen that significantly enhances our HCM solution. This acquisition is a natural fit and allows and follows our strategy. You can expect to see us periodically execute on similar acquisitions; third, M3 profitability continues to improve, once we get the M3 business north of a 10% operating margin you can expect to see us invest in M3 sales and marketing to generate revenue growth.

In conclusion, I'd like to thank and acknowledge the commitment of the 4,000 employees at Lawson who work so hard on our mission, which is to make our customers stronger.

Operator, that concludes our comments, we're ready to take some questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Mark Murphy with Piper Jaffray.

Mark Murphy – Piper Jaffray

Harry, I wanted to ask you in talent management which competitors are you seeing more frequently, recently, the traditional ERP vendors or some of the on-demand vendors. And then also, I guess, given the strength that you saw in talent management this quarter, do you have a feeling that this really will be the year for Lawson in talent management?

Harry Debes

Yes. In terms of the vendors we're seeing, we're kind of seeing across the board but we're seeing more of the point solution vendors in the space. Success factors looked ultimate. Those were the people that we would see more frequently. We're kind of all taking customers from Oracle their former PeopleSoft customers are our classic primary target. In terms of the second part of your question, what we've already seen a significant uptick in our pipeline, and not only pipeline but in our actual results. I think we've said that we saw something like 18 new deals, this year alone half way through the year. I think that momentum will continue, but let's face it it's going to take more than a couple of quarters to really establish ourselves firmly in this space. We do have a good – we've had a great year. We started off with over a thousand customers in the human resources space, but when we took the initiative to expand our product suite into this talent management area and now added the Enwisen solution, we made a bold statement that said, we weren't content to just do payroll and HR, we believe that we could provide Lawson customers and non Lawson customers a very, very competitive offering. Right now, that seems to be paying off. So, yes, I'm very confident about the future for us in this segment.

Mark Murphy – Piper Jaffray

Stefan, are you able to disclose the Healthvision revenue contribution this quarter or maybe ballpark it. Is it on track for the – I think it was $60 million to $70 million type of run rate?

Stefan Schulz

Yeah Mark, it's very hard to break that apart now. Harry mentioned in his prepared remarks that our largest transaction this quarter was from a Healthvision account, but that was primarily sold through the Lawson channel. So it's getting harder and harder to identify that. But, yes, from all indications, we are seeing that this business is on track. Ironically, we're seeing that the license activity is actually performing better than we have planned, the services is probably not as strong as we have planned, but I'll take that trade any day.

Mark Murphy – Piper Jaffray

So Stefan, I think, assuming it's hard to extract it, but assuming it's on track. If that run rate is somewhere in that kind of $15 million to $18 million per quarter range. I mean, I think it's suggesting the business year-over-year is still contracting a little. I know, a lot of that is kind of your downsizing of the consulting business, but do you have a feel for when the business will return to organic growth, is that contemplated in the near-term here?

Stefan Schulz

Mark, that's a good question. In Harry's prepared remarks he talked about the ESM&R shift in phase, where we are actually going through an implementation phase right now versus the strong selling phase and your comments on services are very true as well. So, I would say the combination of those two things, are what drove an organic decline year-over-year in terms of how you would look at that. I would tell you that that will probably be with us for a very short period of time going forward. To Harry's point, we think the ESM&R situation will be back to normal if you will in the next say three quarters or so. I would tell you that we feel like the consulting business is starting to get to a nice stabilization point. So, I would tell you in the next few quarters we should be back to a pure growth type of a mode, yes.

Operator

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

Stan Zlotsky – Deutsche Bank

It's actually Stan Zlotsky. Just a couple of questions, I'm not sure if I missed it. But did you guys say what your conversion rate is or was otherwise?

Stefan Schulz

Stan, we did not, but we can tell you that the conversion rate looking here real quick, it was – actually I need to pull the next sheet out here. The conversion rate was 81%.

Stan Zlotsky – Deutsche Bank

So it went down a little bit because I think it was around 90…

Stefan Schulz

That's right.

Stan Zlotsky – Deutsche Bank

So, just if you guys can talk briefly what are you seeing in the public sector, there is a lot of headlines obviously out there. Municipality is struggling that's out in the other. So, just say what you are seeing out there?

Harry Debes

Well, as I said Stan actually public sector in our second quarter grew again year-over-year and we had a pretty good year last year. We don't think that our growth rate is going to be sustainable at the same level that we had last year because of all of the headlines, because the same news that you know, we know. But at this point we are still feeling good about our solutions set for the state. It isn't just towns and cities there is also school boards, in fact we had great success in a couple of school boards and where Talent Management is very important. There is a lot of focus these days on improving teacher performance and that will improve student performance and that's what our Talent Management focuses are. We have this great success story with the Hillsborough County school district, where we went live in less than five months, tremendously successful projects and that word is getting out. So, if cities are a little bit slow, school boards maybe doing better. We've also had some successes in water boards as well. So, growth continues not at the same pace as we had last year.

Stan Zlotsky – Deutsche Bank

So, do you see not at the same pace?

Harry Debes

That's correct, I said not at the same pace as last year.

Operator

Your next question comes from the line of Richard Williams with Cross Research.

Richard Williams – Cross Research

Just wondered if you could talk a little bit more, hopefully give us a little more color on public sector. Certainly it's a big issue of concern that is it going to impact you as the headlines have expressed or are your customers pre-funding a lot of their investment?

Harry Debes

As I just said to Stan, Richard. We did continue to see growth in our second quarter in our public sector business and we expect that that will continue. The growth is not as strong as the growth was last year. Last year we had double-digit growth in public sector and that was a bit extraordinary, we were a little surprised by that. However the growth continues and that we had a strong performance in public sector in the second quarter. So, right now we're not seeing the impact of what we are reading in the newspaper in our business.

Richard Williams – Cross Research

How about the pre-funding, do you…?

Harry Debes

I don't know what you mean by that, because our customers we have normal payment terms, they have…

Richard Williams – Cross Research

Are your customers having to go through their current budgets to fund the investment or have they accrued the dollars that they are investing?

Harry Debes

Most of the time, by the time that they are ready to sign an agreement budgets have been set aside, usually 6 to 12 months in advance of that, because sales cycles in public sector are 6 to 9 months. So a city or school board wouldn't engage in a sale cycle unless they have received some budgeting, of course it always goes back to the budget control office and sometimes the City Council for a final vote just before they sign the contracts, but we haven't had any kicked back. Let me just point out, our solutions improve the efficiency and save money, even though I know it sounds contradictory to spend money to save money. But that's what this is all about. That's what our whole business is built on. You spend some money to implement our software and within a year to two years you get a return on that investment. So, they're doing this not because they need the places to spend their money, they actually save money, and we have plenty of great business cases and success stories that show where investments in our solutions have actually provided a very, very good return for these companies, so whether it would be public sector or otherwise. So, they're saving money, obviously, not in the first year but subsequently they do.

Operator

Your next question comes from the line of Ajay Kasargod with Morgan Keegan.

Ajay Kasargod – Morgan Keegan

First question is could you give me a little bit more perspective on the breakdown of guidance in terms of Enwisen contribution. Stefan, I heard you comment that Enwisen will contribute minimally to Q3. In prior discussions, I think you – the expectation was Enwisen will contribute $8 million for the back half of the year on a pro forma basis. Can you clarify all that?

Stefan Schulz

For starters, Enwisen is a SAS revenue stream company. So on inheriting that revenue stream upon the acquisition, we're looking at about $8 million for the five months, between January and the end of May. So, breaking that down, we're seeing about three or so of that falling into our quarter three, and about five or so falling into quarter four. Because of the SAS nature of that and because of some of the integration costs that we're talking about, we're really not expecting to see much in the terms of bottom line benefit to either quarter, Q3 or Q4. As a matter of fact, there could be some slight downward pressure, not enough to necessarily affect it materially, but we do see some slight negative pressure from this for the first two quarters.

Harry Debes

If I were to quantify it would probably be something like a $0.05 downward pressure from Enwisen over five months because of the fast nature and also because of the integration effort that we're going through. Now we expect that that will change next year, and as Stefan suggested, that's going to add approximately $0.02 over the course of next year. But we've got a little bit of work to do. But what we're really excited about on this deal is the growth and the revenue momentum and we have personal experience of this because of the two years in which we were a business partner with Enwisen we sold, I think, eight or nine transactions as we have a very solid pipeline with them. So, we're excited about the growth that they'll bring us next year.

Ajay Kasargod – Morgan Keegan

Not a step too far, but only because you commented on Enwisen for 2012, if the implication is that it's $5 million for Q4 then you'd have a big step up in Q1, '12 for Enwisen considering it's a recurring revenue base business. Can you just help us understand why it would step up as much going into Q1 '12, just so we can basically put the modeling in perspective here?

Stefan Schulz

Sure. It's not necessarily just a one big step up, it's a continual step up as we go for Q3 to Q4, Q1 and Q2. A lot of the contracts that were recently sold by Enwisen right before the acquisitions haven't come into play yet in terms of the recognition, those will be coming in another couple of months. Then we also expect to be adding significant amount of contracting in January through May, that's going to allow that to grow. So Ajay, I don't have the numbers exactly in front of me, but I would say I wouldn't necessarily look at it as a one big jump in terms of Q4 to Q1. I would look at a nice good steep ramp going from Q4 through the following Q4 that will get you to about $29 million.

Ajay Kasargod – Morgan Keegan

Seem to very simple, a strong sequential growth based on the actual signings that are going on prior to and right now with Enwisen?

Stefan Schulz

That's correct.

Ajay Kasargod – Morgan Keegan

Just very quickly, you guys didn't provide the mix of new versus existing deals in the breakout, any commentary on that or at least in terms of high level the mix between new versus existing customers in terms of license contracting?

Harry Debes

Yeah, the reason we did that on purpose this quarter and I don't think we're going to do that in the future, and let me tell you why. It's becoming more difficult for us to do that, because with the Healthvision acquisition, with Enwisen and also with the growth of our partner network, it's becoming more difficult for us to monitor all the transactions new, existing, sell through partner, sell through direct channels to be able to give you that color. So, it's just more complicated for us to be able to do that. We were doing that before because our business was smaller, it was 95% or 98% loss and we had very good visibility. Now business partner send us royalty checks and we don't necessarily know how many new – I mean, I think if we drill down and put them under our lamp and drill them we could probably get the answers. But frankly, at a consolidated level we don't always know the answer to that question.

Operator

Your next question comes from the line of Steve Koenig with Longbow Research

Steve Koenig – Longbow Research

I have one question for discussion but if I may just ask a housekeeping clarification. Are you out giving M3 versus S3 licenses in the total revenues like you gave last quarter?

Harry Debes

It's in our 10-Q which I think…

Stefan Schulz

And on our website.

Barbara Doyle

On our website, as well.

Stefan Schulz

Yes, we do. So, all that information is broken out there.

Steve Koenig – Longbow Research

Then my question today really is, maybe you could talk a little bit about what we should expect for both sales headcount trends, how it's in the quarter, what we might expect going forward and also sales productivity, with respect to, you've mentioned you had created an HCM sales unit. So, wondering about any recent changes to your sales or how you might expect productivity to trend layering out to the sales headcount trends?

Harry Debes

Our sales headcount this year I think started at the beginning the year about 180 to 182 AEs, and now we've got about 184. But you can expect that in the second half of this year, we will start to ramp up and in fact, we've got a hiring program underway right now. We're looking for high quality, experienced reps in some cases, and in some cases, we're looking for let's call it junior AEs, people that are less experienced that we can train and we can start with in inside sales function and then gradually give them territory. Some will get existing customer territories or customer AEs as we call them, some will get moved with these territories.

We're not actually going to give you a number that says it's going to be this many, but we're targeting in the 200 AE range or maybe slightly above by the end of our fiscal year. Of course, when we have new AEs, on board whether they're in any of our business verticals, it's going to take 6 to 9 months for them to establish themselves and get a pipeline. So, I think you're going to see this investments that we're making in terms hiring which we're now in the end of our fiscal year start to have impact by the second quarter of next year.

Operator

Your next question comes from the line of Peter Goldmacher with Cowen & Co.

Peter Goldmacher – Cowen & Co.

Two quick questions. Harry, you said you remain very optimistic on ESM&R. Your revenue in Europe is still pretty relatively weak for you guys. What are you seeing that's making you so optimistic in that category, and also I'd love a couple of comments on how you feel like, your decision to deliver Lawson on top of the Amazon Web Services is being greeted by your potential customers?

Harry Debes

So, the first one, ESM&R, I'm very close to that business. I've been posted from the day we began that business, it was one of my pet projects. I've been involved with all of the major signings. I'm involved intimately with all of the customers that we're engaged with right now. They are large from filling [ph], but it that has a 7,000 user license to some of them who have a couple of hundred users. We're deeply into the implementation phase right now. So, we've won the first phase of a number of these dealers in these various OEM relationships.

The other dealers are on the sidelines waiting to see the result of these projects and implementations. They need to upgrade or need to replace what they've got, but they want to make sure that what they're buying is going to work, and is going to work for organizations that are larger, more robust or perhaps we're the early adopters. So they're a little bit right now on the sidelines, going through the early stages of the evaluation, spending a lot of time talking to our existing customers, in fact our existing customers hosting them very regularly.

So, we have a very, very active pipeline of customers, who are constantly meeting with us, meeting with our installing customers, asking very good question, educating themselves, just waiting for these customers to go live and be live for a couple of months and then I think we're going to see the floodgates open. So, that's what makes me confident and because again, of all the business units this is the one that I know the most about because this is the one I'm personally most involved in. So, I could talk about this one all day long.

Your second question which was on Amazon, what's the reaction? Reaction has actually been pretty good. We have a number of customers now, four customers that have in fact engaged with us. I mentioned Scott County as an example, but there are three additional ones that have already begun working with us that have signed deals. We've established a very, very healthy pipeline that, in fact with some surprisingly large transactions in that pipeline – surprising to me in anyways in that pipeline of opportunities. So I am excited about it. I think that in the next couple of quarters we're going to have great traction. So, the interest was high. You can understand that it's going to take a little while for customers to get educated. But now we have four who have already signed up and I think once you get past the initial launch and the initial four customers and them saying come on in the water is fine, our business is running well, I think we will see lot more customers move in that direction.

By the way, that's both new customers and existing customers, who are facing potential hardware or infrastructure upgrades and rather than go that way then going to the cloud opportunity.

Barbara Doyle

To circle back to one earlier question. One of the verticals where we're seeing the most interest in cloud is in public sector, because of the cost pressures they are feeling.

Harry Debes

Yeah, good point. Well, Peter I hope that answers your questions.

Operator

Your next question comes from the line of Brad Sills with Barclays Capital.

Brad Sills – Barclays Capital

Just one on M3. You've commented on ESM&R. Can you comment on some of the other verticals in the U.S., where you are seeing some traction there?

Harry Debes

Yeah, well fashion, food those are all – we call that into our consumer product business section, that's actually doing very well. I think we signed quite a few deals – there were 71 license transaction and I think 9 or 12 or something like that were new deals in the quarter. So, I'm actually pretty pleased with that. That actually has been a very surprisingly strong business unit. It was strong in Q1, it continues to be strong in Q2, and that's across the board, not just the U.S., it was strong in Europe as well, which is very encouraging.

Operator

Your next question comes from the line of Mark Schappel with Benchmark.

Mark Schappel – Benchmark

Stefan, I was wondering if you could provide the foreign exchange impact to revenue in the quarter. I don't have access to some of the supplemental information?

Stefan Schulz

Actually, Mark I can give that to you in just a second, but I can tell you from an EPS perspective it wasn't very large, and so we really didn't see any impact there. Barbara just pulled the number for me here and so essentially from a total revenue perspective it was very small basically at 10 basis points. So, it was very, very small there and then from an EPS perspective it was right at 2% to 3%.

Barbara Doyle

Virtually no impact on currency this quarter, Mark.

Operator

Your next question comes from the line of Neil Herman with Soleil Securities.

Neil Herman – Soleil Securities

Two questions. The first one is with respect to your building SAS business. How big does that business need to be before you would anticipate breaking that out as a separate line item and when do you guess that you might get there? Then second question is a follow-up to the ESM&R business, the sense we've gotten is that you don't have much competition there because they haven't built specific solutions aimed there, have you actually lost transactions or have they been able to do something to slow down commitments of customers to you. Is the issue primarily that perhaps implementations have taken a bit longer than you had thought which is causing other potential deals to slow relative to your expectations?

Stefan Schulz

Neil, this is Stefan, I will take your first question and allow Harry to take the second one. You asked a good question about subscription revenues. I think with the Enwisen acquisition you can probably look for us to make that split happen in the next couple of quarters, more than likely it will be our next fiscal year so we'll probably stay with the current reporting structure where it stays within consulting line item and then we'll probably break that out starting in fiscal '12.

Harry Debes

On the ESM&R question, it wasn't that we didn't have any competition. We had competition in every deal. Every time new customers prepare to spend a $2 million they don't single source the deal. So, on every single transaction we've got competition. I would say that on 70% of them we had SAP and the other 25% we had the Oracle or Microsoft or – that wasn't even actually, not actually Microsoft that we're competing with. We're competing against the Hungarian VAR that is reselling and bundling Microsoft Solution. Here's what's happening, they're becoming more aggressive because they're tired of losing to us. So, they're putting together unbelievable, unrealistic pricing deals because I think some executive somewhere has told them to stop losing to us, so they're virtually offering the software at 80%, 90% discounts and giving fixed price services with unreasonable timeframes. Now, some customers are mature enough and experienced enough to realize that when this to be true it is and some aren't. Those customers are going to learn valuable lessons.

On your second suggestion, are the projects taking little bit longer? Yeah, they are. That's again not really unusual. This is probably of all the businesses and all the solutions we have, the most sophisticated because we're not just automating their financials or their supply chain, we're automating the entire business, everything that they do from HR to supply chain to sales to warranty claims, to service orders, to mobility, to warehouse management, logistics, everything. This is suit to nuts. Nobody is buying just the financials or just the HR. This is a full replacement. It's a heart lung transplant for these companies. And it's a big test. I would tell you, much of the issues are on their side because I don't think they appreciated when we started the project what a massive undertaking it is and how much effort their staff actually have to put into it. But we're going to get there.

First of all, we already have three customers live, so I don't want you to think that this is, 'Oh my gosh, this is never going to happen. We've got three customers live and they've been live for over a year and everything is looking great. We just have another seven or eight in the pipeline that we'd like to get live. I think one of them is going to go live within two or three months, and then the rest will be live throughout 2011. So, this is a blip in the curve, and I don't want to read too much into it. I would like to explain it because it's worth explaining because – compared to last year, it's disappointing from the results perspective, but in terms of results, it's a blip in the curve.

Operator

Your next question comes from the line of Brian Murphy with Sidoti & Co.

Brian Murphy – Sidoti & Co.

I haven't seen this quarter's breakdown, but just looking at the revenue mix by business segment. Harry, could you remind me why is consulting so much higher as a percentage of overall M3 sales that are relative to S3, is it just partners there and do you expect that mix to change over time?

Harry Debes

Sure, I'll take that question. Your question was why is M3 services revenue so much higher, right, as a percentage of sales. Well, I'll tell you it used to be almost twice as high as what it is today. It used to be something like 60% of total revenue and that's just historical from the former Intentia Company, because they did not believe in a business model where they were third-party service providers. So they basically provided 100% or 90% of the services themselves, which led to a boom or bust revenue cycle in the quarter. When business was really great all their services people were busy and they could deliver lots of revenue. When it wasn't so great, they had a lot of people sitting on the bench and all of a sudden they had this fixed costs and they were losing money, and it was a bull or bust cycle.

Customers also weren't happy with it because they only had the single source of supply. We've adopted a partnering model, so where we've said, we will reduce our capacity, enable partners to get established and then, share the revenue, as long as those partners help us deliver license revenue and that's what we've been adopting. So, that's why our revenue now as a percentage is lower than it was, but still relatively speaking higher than the M3 Business. So, I think right now it's about 48% from 60 some percent in the past. So, I hope that answers you. Now, by the way our trend is down and if you look at Q2 by the way is a blip, it went up. But that's because Q1 is holidays in Europe and that's why Q1s always book a very, very low services revenue month quarter for us. If you track us on a historical basis, you will see that it has trended down and it will probably continue to trend down further a lot. Our target is mid 30% range.

That was the last question. Thank you for joining us today. As I said in my opening remarks, we had a very good quarter. When it came to the S3 Business, I think the S3 Business hit it out of park in pretty much all metrics, contracting growth, total revenue growth, organic growth, Healthvision continued to contribute and execute strong bottom line results on S3, so, very good performance.

On the M3 side, I said at the very beginning, our focus was improving profitability. That's what everybody asked us about at the end of Q1. That's what we said we were focused on, that's what we are focused on. If that means we must give up some short-term revenues in order to get the business healthy and stable, and as I said, to our short-term target of about 10% bottom line, we're going to do that. We're going to continue to be tough on expenses and on investments, until we get to a bottom line that we feel comfortable with. Then when that business is running solidly, you will see us reinvest in the top line, which means sales and marketing and that will of course result in revenue growth. That's our game plan and that's what happened. The only blip was that ESM&R didn't perform as well as last year.

Okay, I explained that at length I hope you understand. I don't think that that's a long-term scenario. But in general I feel very good about the quarter, I feel good about our next quarter and I feel good about this year. I feel particularly good also about the Enwisen acquisition. It's something that we've been talking to you all about for three or four quarters now, saying at some point we're going to do an acquisition that's strategic, that's going to fit, make obvious sense, I think this one does. I think it will have a great future for us inside the Lawson Company. Well, thank you for your call. We look forward to speaking to you again at the end of next quarter.

Operator

It does conclude today's conference call. Please disconnect your line at this time.

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