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JDA Software Group (NASDAQ:JDAS)

Q4 2010 Earnings Call

February 01, 2011 4:45 pm ET

Executives

Mike Burnett - Group Vice President of Treasury & Investor Relations

Peter Hathaway - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Hamish Brewer - Chief Executive Officer, President and Director

Analysts

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC

Brian Murphy - Sidoti & Company, LLC

Richard Williams - Cross Research

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the JDA Software Group Incorporated Fiscal Fourth Quarter 2010 Earnings Conference Call. [Operator Instructions] I'd now like to turn the conference over to our host, Mr. Mike Burnett, Vice President of Treasury and Investor Relations. Please go ahead, sir.

Mike Burnett

Thank you, Elise. Good afternoon, and welcome to the JDA Software earnings call for the fourth quarter and year ended December 31, 2010.

Consistent with our expectations, we closed out the year with strength and momentum that leads us into 2011. Record revenues in the fourth quarter, combined with a successful acquisition and integration of i2, resulted in record EPS for the quarter and the year.

On today's call, we will recap our results for the fourth quarter and the full year, and we will discuss our outlook for 2011. With me on the call today is Hamish Brewer, Chief Executive Officer of JDA Software; and Pete Hathaway, our Chief Financial Officer.

Before we begin discussing our results, let me remind you that our comments today will contain certain forward-looking statements that often involve risks, uncertainties and assumptions. All statements other than statements of historical facts are statements that could be deemed to be forward-looking. These risks are described from time to time in our SEC reports including, but not limited to, our annual report on Form 10-K for the year ended December 31, 2009.

Our presentation also includes certain non-GAAP measures, which JDA uses internally in budgeting and performance monitoring activities to gauge our business performance. We believe these measures provide useful information to our investors in evaluating JDA's ongoing business results. We prepared a reconciliation of each of these measures to the most directly comparable GAAP measure in our press release, which is posted on our website at jda.com. Additionally, we have posted a supplemental presentation slide deck on our Investor Relations website to accompany the review of our results.

With that, I will now turn the call over to Hamish Brewer, for a discussion of the operating results and trends. Hamish?

Hamish Brewer

Thanks, Mike. The fourth quarter was a great way to end 2010. We aimed high in 2010 and achieved all of our major objectives. Now I'd like to briefly discuss those achievements and also highlight some areas of improvement that we're going to work on in 2011.

The first and, of course, the most important achievement of 2010 was that we successfully integrated i2. We hit our revenue objective. We grew license sales. We grew the i2 business. We achieved our cost energy goal. And most importantly, we've got great feedback from our customers.

They've reviewed our strategy to create The Supply Chain Company, and voted in favor of it in many important ways in 2010. They told us that they like the product roadmap. They showed up at our user conference in record numbers. They bought record quantities of new licensed software from us. They renewed their maintenance contract with record retention rate. And they're paying their invoices on time, driving excellent DSOs. With this support, we're extremely well placed to take what we've started in 2010 and move upwards to new heights of performance in 2011.

So strategically, I feel that the company has a very clear mission, and we're firmly set on a path to achieve that mission. We're taking market share. We're winning the hearts and minds of our customers. We're driving organic growth. And we're very well placed to establish the undisputed market leader in the supply chain management market over the coming years. From an execution perspective, I was pleased with many of the achievements of 2010, but of course there are also areas that we plan to improve further in 2011.

Briefly reviewing our operations from top to bottom. First, our R&D organization. We've integrated the i2 and JDA development teams, built a multiyear product roadmap, and at the end of year one, we are on track with the delivery of that roadmap. In fact, last year, we achieved a 95% plus on time, on scope delivery performance from our R&D organization, which is a world-class performance.

Our sales and marketing organization is generally performing well with some areas for improvement. First, our sales performance in North America was solid, with a very strong finish for the year, delivering over $30 million in licensed sales in Q4, a record for this region. I firmly believe that we've taken significant market share from our competitors in North America, and I expect that to continue in 2011.

Speaking of 2011, the first data point that we have relative to willingness of companies to invest in IT was the NRF Trade Show in New York a couple of weeks ago. Attendance at the event was significantly up over 2010, and our schedule of meetings was the busiest it's ever been. With this in mind, I'm optimistic that our customers intend to spend money on IT in 2011 and that we will, once again, be the recipient of a healthy share of that investment.

In Europe, we underperformed. And of course, the market there had a number of macro issues that give me reason for concern in 2011. Internally, we've made good progress with our sales organization, but we still have much to do. Despite these concerns as we enter 2011, our pipeline for the first half looks stronger, and I'm hopeful that we'll make significant progress with license sales growth in 2011 in Europe.

Asia-Pacific delivered a solid 2010 despite a tough compare from 2009 when we closed a record deal for the region in the second quarter. As I've mentioned before, with the concentration of manufacturers that are well suited for the i2 suite of products in this region, the opportunity for growth created by the i2 acquisition is significant in Asia-Pacific. And once again, I'm optimistic that we will drive meaningful growth in licensing sales in 2011 in this region.

Our Services business was a mixed story in 2010. Our Consulting Services business achieved strong revenues with the addition of i2, but we still struggled with gross margins. We've established a three-year plan to increase gross margins in this business to our goal of mid to high 20s. Although, I only expect to make more incremental progress towards that goal in 2011.

On the other hand, our Managed Services business made excellent progress in 2010. You may remember that we announced the fact we were going to develop the Managed Services business in 2009, and that we expect it to start to drive revenue growth in 2010. I'm delighted to report that we achieved our objective. In 2009, we laid the foundation, building the organization processes and systems, and we created a pipeline of new business. Then in 2010, we successfully started converting our sales pipeline and clearly established our competitive value proposition.

With over 6,000 companies worldwide operating JDA applications, we have a sizable addressable market, and we have a compelling value proposition for those customers, which we call the JDA Private Cloud. The JDA Private Cloud is a global delivery platform that allows our customers to deploy JDA solutions faster at lower cost and with better results than ever before. The value proposition is resonating well with our customers, and they've told us that they're very open to taking advantage of this opportunity.

We picked up about $20 million of Managed Services revenue from i2, and then organically grew this business by about another $10 million from both JDA and i2 customers across the globe in 2010. I expect our JDA Private Cloud offering to continue to drive organic growth throughout 2011 and beyond.

Our maintenance and support operation effectively delivered a 10 out of 10 performance in 2010. We knew that maintenance retention was not going well at i2 when we acquired the company, running in the low 80s, and I talked throughout the year about the challenges of turning this around. So I'm delighted to be able to report that we did better than, I think, we could have ever expected, and effectively delivered just about perfect maintenance retention of almost 96% in 2010. It simply doesn't get better than that in the enterprise software space. As a major driver of earnings and cash for the company, this is a critical performance statistic.

Finally, we delivered real operating leverage from our G&A functions, reducing G&A as a percentage of total revenues from 11.8% to 10.2% in 2010 compared to 2009. In 2011, we're going to continue to work on our systems and organization with a goal of establishing an operating platform for the business that can deliver further efficiency and be ready for the growth we plan to achieve in the next two to three years.

Of course, we continue to deal with the Dillard's lawsuit and expect that process to continue throughout 2011, unless if we're able to reach agreement with Dillard's on a settlement. You'll see that we have increased our reserve for this lawsuit from our original $5 million to $19 million based on some unsuccessful preliminary mediation discussions with Dillard's. We're now underway with the appeals process, which is expected to continue throughout most of 2011. Because the appeals process effectively distributes all of the existing evidence, this is not going to be a major distraction for the company throughout 2011, and we intend to focus on driving top line revenue and continuing to improve our systems and infrastructure so that we'll be ready to proceed with our strategic plan as soon as we know how much this lawsuit is really going to cost us. I'd like to remind all of you that there are no other material customer disputes across our entire customer base.

On the subject of litigation, the court date is set for the Oracle infringement of our patent in early March this quarter, and we feel we have a good case. I'll update you if and when we have any material progress on this case.

Summarizing all of this, I feel very good about what we achieved in 2010. Our strategy is working. Our customers are engaged and investing in JDA. Our competitive position is strong. And with a few exceptions, the company is working well and preparing for growth, which brings me on to our outlook for 2011.

There are several factors that have gone into the creation of our business plan for 2011, and I'd like to review these with you before presenting the numbers. First, I want to take advantage of the current strong win rate and apparent opportunity to seize market share, particularly in North America. So we've decided to increase the size of our sales and marketing organization, and we've decided to establish a robust sales growth target for us out in 2011. So you're going to see solid top line software sales growth in our projection, along with a sizable increase in sales and marketing expense. The outcome of this is that sales and marketing expense as a percent of software revenue is going to be about flat compared with 2010.

Second, as I mentioned earlier, we've created a three-year plan to get to our goal of mid to high 20s gross margin percent in our Consulting Services business. Progress towards that goal is going to be minimal in 2011, picking up as we proceed. Even though we're coming off a strong revenue growth year in this part of our business, we expect top line revenues in our Consulting business to continue to grow. And of course, the growth we anticipate in our Managed Services business will further expand our total Services revenue.

Third, although we achieved a perfect result in maintenance retention in 2010, it would be aggressive to just do the same in 2011. Consequently, we're planning to return to more typical JDA retention rate of between 93% and 95%, which is still right at the high end of the industry. Factoring in the license growth, gives us a revenue projection for 2011 of about $255 million, representing modest growth over 2010. As we've seen before, we believe the biggest variable in this revenue line could be some currency fluctuations, which we do not attempt to predict.

Moving on to R&D. We intend to increase the dollar amount we invest in R&D to keep pace with the growth of the company. Our goal is to keep R&D, as a percentage of revenue, the same in 2011 as it was in 2010. I believe our investment and innovation has provided us with a competitive advantage that we intend to keep.

As I alluded to earlier, we're going to be making some investments in our internal infrastructure in 2011 in preparation for growth to our stated goal of $1 billion in revenues. In addition, we expect legal expenses for Dillard's and Oracle to remain about the $10 million mark. However, despite these expenses, we have been able to keep our planned G&A expenses under good control, and G&A expenses will likely improve slightly as a percentage of total revenues in 2011.

Coming back to the exceptional legal expenses, it's worth noting that we expect the litigation cost from Dillard's and Oracle to be heavily front-end loaded during the year, essentially, as much as $7 million in Q1, as our case in Oracle is expected to go to trial in March.

So when you put all that together, we expect to be able to generate between $650 million and $690 million of total revenue, with $145 million to $160 million coming from software sales, representing more than a 15% year-over-year increase in software sales using the midpoint of the range. We expect to generate between $170 million and $185 million of adjusted EBITDA in 2011, which at the midpoint would represent a 10% year-over-year increase, and expect to increase adjusted EPS to a range of $2.00 to $2.20 a share, which using the midpoint of the range, would represent an increase of almost 10%.

Turning to cash flow for 2011. We expect to generate between $115 million and $130 million of cash flow from operations. From that, we expect to spend $25 million to $30 million on capital expenditures, resulting in $90 million to $100 million of free cash flow. If you use $100 million free cash flow number, we would be generating about $2.35 of free cash flow per share.

And with that, I'll hand it over to Pete.

Peter Hathaway

Thank you, Hamish. As Hamish mentioned, we are pleased with the strong results generated in the first year of combined operations with i2. We believe that 2010 has proved a solid foundation for continued profitable growth in 2011. We accomplished the financial goal that we set out for the organization in the beginning of 2010. Both software revenue of $131 million and total revenue of $617 million were in the upper half of our guidance range.

Adjusted EBITDA of $161 million and adjusted EPS of $1.95 were within our guidance ranges, and would have exceeded the top end of these ranges if we had not incurred the $9 million of unusual litigation-related costs for the Dillard's and Oracle matters.

We met our acquisition cost savings goals of $20 million. Cash flow from operations of $65 million was below our original targeted range due to classification changes related to acquired deferred revenue and i2 acquisition cost. Nonetheless, we exceeded our revised guidance by $10 million, closed out the year with over $206 million of cash on the balance sheet, and are poised to produce about $100 million of free cash flow in 2011. And most importantly, we exit the year operating as one integrated company, JDA, The Supply Chain Company.

Turning to specific commentary on the results for the fourth quarter 2010. Adjusted EBITDA increased 77% to $48.5 million from $27.3 million in Q4 2009.

2010 adjusted EBITDA includes $3.1 million in litigation cost not incurred in 2009. The adjusted EBITDA margin increased 230 basis points to 28.7% from 25.5% in the fourth quarter of 2009. On a sequential basis, the adjusted EBITDA margin increased 370 basis points. This substantial sequential increase was driven by higher margin revenue mix and disciplined cost containment.

Adjusted earnings per share increased 42% to $0.61 from $0.43 in the fourth quarter 2009, primarily due to the profitable growth from the acquisition of i2 and the achievement of the cost savings associated with the acquisition. Adjusted EBITDA and adjusted EPS figures exclude the conventional items related to amortization, stock-based compensation, unusual litigation and the i2 acquisition transition and restructuring charges, all of which are separately identified in the tearsheet attached to the press release.

As Hamish explained, during the fourth quarter, we recorded a $14 million noncash, pretax charge associated with an increase in the litigation accrual for the pending matter with Dillard's. During mediation, we made an offer to settle the matter for $19 million. As required by GAAP, our balance sheet now reflects the $19 million liability. As we already had a $5 million accrual on the books, we recorded the difference of $14 million during the quarter.

Total revenues increased to $168.8 million for the quarter, including a record $42 million of software and subscription revenue, as compared to total revenues of $107.1 million and software and subscription revenues of $28.6 million for the fourth quarter 2009.

We closed 84 new software deals in the quarter compared to 69 in the fourth quarter last year, including 10 large transactions of $1 million or more. Our average selling price for the trailing 12 months ended December 31, 2010, increased to $601,000 from $573,000 in the third quarter of 2010.

Maintenance revenue, which represents the foundational cash flow of our business, continued to be very strong in the fourth quarter. Our customer retention rate on expiring maintenance contracts continues to be among the highest in the industry. We ended the year with a retention rate of 95.6%. This is a fantastic result and compares quite favorably to the 92.4% in 2009.

Maintenance revenues increased to $64.4 million in Q4 2010 compared to $47 million in the fourth quarter 2009. And the maintenance gross margin increased to 79% from 77% in Q4 2009. The margin improvement comes from leverage resulting from the acquisition. This recurring, high-margin revenue and cash flow stream now represents more than a third of our total revenue.

Services revenue almost doubled to $62.4 million from $31.5 million in Q4 2009, while our gross margin increased to 18.2% for the quarter compared to 16.2% in Q4 2009. The utilization rate was 53% for Q4 2010 as compared to 55% in both Q4 2009 and Q3 2010.

As Hamish noted in his remarks, we have experienced phenomenal growth in the Services area, and along with it, have experienced some growing pain. We will continue to take the approach of servicing the customers at the highest level, while taking measures to improve our efficiency and productivity.

One point that, I think, is important to highlight is the impact of the change in our revenue mix has had on our gross margin. Prior to the acquisition of i2, our revenue mix was split about 70% product revenue, consisting of high-margin software and maintenance revenue, and about 30% lower-margin services revenue. Subsequent to the acquisition, that ratio is now 60%:40%, with a greater proportion of lower-margin services revenue.

If you analyze the maintenance and services gross margins for the independent lines of business, you'll note a 200 basis points year-over-year increase in both. However, gross margin for the whole business is actually down year-over-year by 360 basis points because of the change in mix. In spite of the impact of the revenue mix change on gross margin, our operating and EBITDA margins for the whole company are substantially up year-over-year, signifying strong operating leverage from the acquisition.

We can see that impacting the operating cost structure. Total operating expense as a percentage of revenue improved to 36% in Q4 2010 compared to 42.9% in Q4 2009. This excludes the amortization of intangibles, restructuring charges, acquisition related and litigation charges.

Product development expenses this quarter increased to $18 million from $13.6 million in Q4 2009, primarily due to the addition of the cost associated with i2. However, as a percent of total revenue, product development cost declined 200 basis points to 10.7% from 12.7% in the prior year's fourth quarter.

Sales and marketing expenses also increased this quarter to $25.5 million from $19.7 million in Q4 2009 due to the addition of i2. However, as a percentage of total revenue, they decreased to 15.1% from 18.4% in Q4 2009. This decrease is primarily due to record software sales in the fourth quarter and the resulting cost leverage from the i2 deal. We ended the year with 92 quota-carrying sales associates.

Similarly, general and administrative expenses increased to $17.3 million, excluding the $14 million previously discussed litigation adjustment, from $12.7 million in Q4 2009. As a percentage of total revenue, these costs decreased to 10.2% from 11.8% in Q4 2009, as we gained cost leverage from the larger scale presented by the i2 acquisition. We incurred $3.1 million of legal expenses in the current quarter associated with the patent infringement litigation i2 filed against Oracle and the Dillard's matter.

Net interest and other expenses increased to $5.7 million in Q4 2010 due primarily to interest on the $275 million 8% senior notes issued in connection with the acquisition of i2, amortization of bank fees and a $354,000 unfavorable impact due to currency exchange rate changes.

The effective tax rate for the quarter on GAAP earnings was 8.8%. This differed from the adjusted effective tax rate of 35% due to a reversal resulting from the lapsing of the statute of limitations for an item that was recorded as a contingent tax liability in prior years. The pro forma effect of tax rate remained at 35%. Weighted average shares outstanding for the quarter ended December 31, 2010, was 42.3 million.

Now turning to cash flow. We generated $26.2 million in operating cash flow in Q4 2010 compared to $16 million in Q4 2009. The increase in operating cash flow for the current period was primarily driven by improvements in working capital and successful collection efforts as evidenced by the DSO in the fourth quarter 2010 decreasing to a record low of 54 days from 56 days in Q3 2010 and 58 days in Q4 2009.

We spent approximately $2.1 million on capital expenditures during the quarter compared to $1.6 million of CapEx in the fourth quarter of 2009. For the full year, we spent $16.9 million on capital expenditures, with approximately $8 million supporting growth in the JDA Private Cloud offering. Our cash position at quarter end increased to $206.5 million including restricted cash, leaving a net debt position of approximately $68.5 million, a leverage ratio net of cash of 0.42x and an interest rate coverage of 7.3x, all very healthy credit metric.

I'll now add a couple of notes to what Hamish said earlier about 2011 expectations. Both interest expense and cash interest are expected to be similar to 2010 at approximately $25 million. Our effective tax rate is expected to be approximately 35%, only $15 million of which is expected to be paid in cash during the year. And fully diluted weighted average shares are expected to be between 42.5 million and 43 million.

We expect to spend $25 million to $30 million on capital expenditures. About $3 million of the year-over-year increase is CapEx rolled over from 2010, and the remaining $5 million is associated with the continued build-out of the Managed Services offering that saw an increased success in 2010. This business, our JDA Private Cloud offering, saw about a 50% increase in revenue in 2010.

This is a capital-intensive business due to the hosting component, and is expected to be a long-term organic growth engine for the company. With expected EBITDA margins in excess of 30%, the ROI on this investment should be solid.

In summary, 2010 was a benchmark year for JDA, in which we successfully acquired and integrated i2 Technologies, created The Supply Chain Company and successfully launched the JDA Private Cloud. We are going to build on that momentum in 2011 with near double-digit growth in both revenue and earnings, while still investing in the long-term growth prospects through increased investments in sales and marketing, product development and the JDA Private Cloud. We expect to generate $100 million in free cash flow, representing $2.35 per share. Our investments, our market-leading position, our industry-leading execution and our long-term growth and cash flow position JDA to continue to provide value in the coming year and beyond.

And with that, I would like to open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Richard Williams with Cross Research.

Richard Williams - Cross Research

I noticed on the EPS guidance that it was a bit less than prior consensus. Could you give some more color on what's going on with the moving parts behind that?

Peter Hathaway

Sure, Rich, this is Pete. I think in taking a look at where the consensus is versus our guidance, I think the primary difference is the investments that we're making in sales and marketing in particular, as Hamish outlined, we have agreed that we think it's appropriate to continue to spend on product development at a level which is commensurate with our percentage of revenue that we had last year in 2010, so that will be equal to 2011 on a dollar amount. I think that increases a little bit, too. I think those are the primary differences.

Richard Williams - Cross Research

How would the Oracle settlement, the Oracle ruling play into this? Because I kind of view that as a wildcard. How do you think of it?

Hamish Brewer

To be honest with you, Rich, we didn't really factor it into our business plan at all, except to the extent that we know we're going to incur it this year. Yes, we feel that we've got a strong case. Obviously, likely, we believe that we're going to get a positive outcome. We don't know what the timing of that is. We don't know if they might settle it beforehand or we might enter into some kind of appeal process but it's really hard to know exactly how that's going to play out. So we just factored it in the expense because we knew we were going to have that expense. And that was pretty much it. We didn't really put a lot more thought into our 2011 plan other than just that.

Richard Williams - Cross Research

And this is a very similar suit to the one that i2 won? I think it was $83 million they won.

Hamish Brewer

Yes, it's basically the same patent protection, patent provision that we're asserting against Oracle.

Richard Williams - Cross Research

And that judgment, am I correct, comes early March?

Hamish Brewer

The court case is set for, yes, early March. I think it's March 14.

Richard Williams - Cross Research

Also give us some color about the Managed Services business? How is that coming along compared to what you were thinking, say, six months ago?

Hamish Brewer

I think we're in good shape. Like I said, we picked up $20 million from the i2 acquisition. We grew that organically with new business to the tune of $10 million in 2010, which I was pretty happy with. And I think that we, based on how the pipeline for new business booked, et cetera, that we're going to continue to grow that business reasonably aggressively in 2011. So I think over time, Managed Services is going to become a sizable revenue stream for the company. It's clearly growing pretty aggressively. And I don't see any reason why we shouldn't be able to achieve the goals that we set out in the first place when we decided in 2009 to start this business.

Richard Williams - Cross Research

How many accounts did you add in the quarter?

Hamish Brewer

I don't have the number, the number of deals we did in the quarter, off the top of my head, but I'll try to get that and get back to you with it.

Operator

[Operator Instructions] Our next question comes from the line of Jeff Van Rhee with Craig-Hallum.

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC

Maybe just start with the sales side, would you expand on what the incremental spend is that you're putting for '11 to build out the sales capacity? And what is it that you will get for that spend?

Hamish Brewer

Yes, people. We're going to hire more sales reps. We're going to hire more pre-sales people. We're expanding our sales and marketing organization. I think that when we look at what happened in 2010 with the strong win rates and the competitive opportunities that we had in the marketplace, obviously, we finished the fourth quarter with a great result in terms of software license sales. And so we've decided to also have a pretty aggressive top line software license growth target for 2011, and we're building out the infrastructure to help us deliver that in 2011 and hopefully create a platform for further growth in 2012. Obviously, building the sales organization is not something that happens overnight. We'll get some benefit from the investment in 2011, but it's going to position us well for further growth in 2012. And that's kind of the thinking behind it.

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC

And can you maybe quantify where you think you would end the fiscal year in terms of direct reps?

Hamish Brewer

I think our plan at the moment is we've currently got somewhere in the region of 90. I think we ended year with just over 90 quota-carrying people. And we're going to be adding something like 25. So it's a pretty sizable increase percentage-wise that we'll be layering in over the course of the year.

Jeffrey Van Rhee - Craig-Hallum Capital Group LLC

And just sort of a higher level view of the industry. For the year, certainly, with integration, a lot of things going on, you had a lot on your plate. But what are your thoughts as to what the actual end markets grew this year and what you think is a reasonable baseline for fiscal '11? How are you looking at that?

Hamish Brewer

I'm not sure that the market as a whole grew in 2010. But I am convinced that we took some market share during the course of the year, just based on our win rate. So I mean, if you look at Gartner, they say the market is growing at 5%. I don't know. To me, I'd be surprised if it's growing at 5%, overall. But I'm absolutely convinced that we're taking market share. But when I look at 2011, I think the market will grow. And like I said, the only real data point I've got so far is the NRF Trade Show that we had in New York. Attendance was really strong. And it wasn't just the number of people showing up, it was the quality of the new themes and the discussions we're having. It looks like people are really intending to spend on IT in 2011. And I think that our competitive position, I think we're pretty well placed to grab a good share of that. And again, that's sort of the color or thinking behind this aggressive approach on building the sales and marketing organization.

Richard Williams - Cross Research

On the Services side, can you expand or just give us a little bit more color, certainly, it had been a challenge coming into the i2 deal, and then they brought some notably higher margins on the Services side. Is the margin challenged in the Services side isolated to either legacy JDA business, the legacy i2 business? Or if you can't slice it that way, can you give us a little more color as to what's presenting the challenges around getting higher utilization and some better margins out of the organization?

Hamish Brewer

Yes, it took us a while to really figure out what, in JDA terms, the actual Services margins were out of the i2 business because there was a lot of reclassifications that had to happen because of the way that they looked at the business versus the way that we look at the business. When I talk about Services margins, what I'm talking about is Consulting Services margins, implementing project. I'm not including Managed Services margin, I'm not including, perhaps, other areas of the business. So when we really created an apples-to-apples comparison, I think what we found overall was that we had some challenges with making sure that we were going to be able to deliver on some of the projects that were out there. We had challenges with transitioning, resources, cross-training resources and those sort of things. And what we decided, and I think we mentioned this a couple of times last year, was that we were going to put the quality of the deliverables to our customers first. So the first thing we want to do is make sure we didn't drop the ball with any of our major customers. I think we did that pretty well. And in fact, in the course of doing that, we drove revenues up pretty significantly. We got some margin expansion in 2010. We've got a little bit more in 2011. But really, I think that the -- just like what I'm talking about when I say we've got like a three-year plan to grow our Consulting Services gross margin, we're really going to be looking at a number of changes in mix of how we go to market, how we deliver our services, the packages that we deliver our services through, the way that we deliver it, the blend of onshore and offshore services. So there's kind of structural changes that we're going to be working through in the course of the next two to three years, which we believe ultimately will get us to that goal of sort of mid to high 20s gross margin.

Operator

Our next question comes from the line of Richard Power [ph] with [indiscernible].

Unidentified Analyst

From your revenue guidance, with the faster growth in license, that would naturally push up gross margins. Can you talk about gross margins a little bit and how we should think about them for fiscal '11?

Peter Hathaway

Yes, I mean, gross margins on the sales biz, on license, it shouldn't really change a whole lot from what you saw in 2010.

Hamish Brewer

Most of our cost in gross margins in license sales are really embedded as part of product. They go pretty much in line with license sales.

Unidentified Analyst

Right. But if license is going to grow faster than overall revenues in fiscal '11 then that should help overall gross margins, shouldn't it?

Hamish Brewer

The blend of the whole -- yes, we're also expecting some Consulting Services revenue growth that Pete was talking about we saw in 2010. That engine just needs to keep moving forward even though we had a strong growth year in 2010. So yes, you're right. The increase in the software license sales is going to drive gross margins up. And then to the extent that we have Consulting Services revenue growth, that's going to drag it back down again a little bit.

Unidentified Analyst

Right. Yes, that will have the natural pressure on it. And then I wanted to understand, and to make sure I understand the selling and marketing expense guidance a little bit, you said it would stay on roughly the same as a percent of software. Is that a percent of the license revenues or the license plus subscription?

Hamish Brewer

License plus subscription.

Unidentified Analyst

Okay. So that should probably add in the neighborhood of about 100 basis points of selling and marketing expense in fiscal '11? And then R&D is flat and then G&A improved slightly, you guys said?

Hamish Brewer

Yes, I think that's a little bit more on the license or on the sales and marketing side.

Operator

And our next question comes from the line of Peter Avalone with S.A.C Capital.

Unidentified Analyst

I wanted to just try and focus on the litigation costs and just understand if you guys could quantify exactly what's baked into the guidance. Because as it seems to me, the sales side wasn't looking for too much margin expansion or leverage from the product development, so perhaps the more likely culprit is additional legal expenses that perhaps you weren't expecting. Can you just elaborate on that?

Peter Hathaway

Pete, this is Pete. We expect to spend roughly $10 million in litigation cost, similar to what we spent this year in 2010. And as I think Hamish mentioned, we expect most of that to be incurred in the first quarter, about $7 million of that in the first quarter. After that, there'll be some other ongoing expenses to kind of continue to manage through the appeals process with Dillard's and on the Oracle case. There'll probably be some residual expenses there, too, but we think that will probably trail off in Q2. This will be ideal, assuming we get this resolved in March. So that's the way we see the legal expenses that we've built into the guidance playing out.

Hamish Brewer

And as I mentioned earlier, we haven't factored in any upside outcome from Oracle.

Operator

[Operator Instructions] Our next question comes from the line of Brian Murphy with Sidoti & Company.

Brian Murphy - Sidoti & Company, LLC

I just have a follow-up to the sales force expansion, it looks like a pretty aggressive ramp up next year. Hamish, can you tell us why sequentially the number of quota-carrying reps is down in Q4? Is that sort of just the last of the rationalization from i2?

Hamish Brewer

Yes, that's just normal churn. Nothing particular to say about that really -- I mean, we had some resources that were headed out the door, some people.

Brian Murphy - Sidoti & Company, LLC

And on the Managed Services side, did you tell us how many customers were on Managed Services at the end of the year?

Hamish Brewer

No, I didn't have that number.

Brian Murphy - Sidoti & Company, LLC

Oh, okay. I'm sorry...

Peter Hathaway

We'll give it offline.

Brian Murphy - Sidoti & Company, LLC

So could you remind us about sort of, just as a percentage of the installed base, what percentage of your installed base is sort of candidates for Managed Services? And remind us again what the value proposition is there?

Hamish Brewer

Sure. I think anybody who's managing a reasonable size footprint of JDA applications is a candidate for Managed Services. And that means, we're talking about probably at least 1,000 or 2,000 customers, probably in that range, 1,000 to 2,000 customers. I don't know the exact number off the top of my head, but I'm guessing that we ended up the year somewhere in the sort of 80 to 100 range. So that gives you a sense of how far we are in for that customer base. And we still have a long way to go. An effective value proposition is that there are industry studies out there that shows that you will spend several times the original license cost per annum running your complex enterprise application. And we can do that for our customers significantly cheaper than they can do it by themselves. Then this just comes down to synergies and operating leverage because if we're running an application for 25, 50 or 100 customers or 200 customers, we're doing things several hundred times over. We can build in automation and repetition and those sort of things, and get synergies into ops scale, operating scale that our customers simply can not do because they're all doing everything one-off. And so there's a significant cost saving that we can deliver to our customers. There's also operational improvements that we can deliver to them, typically if you go and ask our customers how satisfied are you with your ability to be able to run these applications, some of which are quite complex and require some pretty in-depth knowledge and understanding. In general, they'll say, it's tough for them to maintain the main knowledge to really do a good job. But of course if we are doing it as a -- if we're running our own applications, it's pretty easy for us to do a good job because really nobody knows them better than we do, so we can usually deliver a high quality service to our customers. And if we go beyond simply running the applications for them and actually start to get into the business metrics and analytics, then we can also help them improve the results that they achieved from those applications, not just in terms of running them but actually making better business decisions as a result of running the application. That's where we can really add value significantly beyond just cost savings. So those are the basics for the value proposition. And to be frank with you, we feel like our competitive position is pretty strong when we go out there and try and sell against competitors. We don't really have too much trouble convincing our customers that everything I've just said to you is true.

Brian Murphy - Sidoti & Company, LLC

And just thinking about the growth there, you inherited a $20 million business in Managed Services business from i2, and you added an incremental $10 million. I mean to what extent do you think that was low-hanging fruit? Or do you think that incrementally you could add -- you would expect that business to sort of accelerate?

Hamish Brewer

I think in terms of growth, we generate internally and organically, I would expect it to accelerate in 2011. We probably thought -- yes, there's probably some low-hanging fruit there but not a lot, to be honest with you. Really, we think that the value proposition that allowed us to win the business we got in 2010 is every bit is strong with regards to 2011. And in fact, you can even argue the opposite because if you imagine that we're coming to you and saying, "Oh by the way, we'd like to run these supply chain systems for you." One of your first question is going to be, "Well, how many others? How many other companies are you doing this for?" And when you're starting up a business, that number is not very big. And so actually, in some centers, even a greater hurdle getting the first customers than it is maybe getting the 101st customer.

Operator

And we have no further questions at this time. I'd like to turn it back to management for any closing remarks.

Hamish Brewer

Okay. Well, thank you very much for joining us, and we look forward to talking with you again for our first quarter earnings results in early second quarter.

Operator

And ladies and gentlemen, that concludes our call for today. Thank you for your participation. You may now disconnect.

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