JDA Software Group Q3 2007 Earnings Call Transcript

JDA Software Group Inc. (JDAS)

Q3 2007 Earnings Call

October 22, 2007 4:45 pm ET

Executives

Hamish Brewer - Chief Executive Officer

Kris Magnuson - Chief Financial Officer and Executive Vice President

Analysts

Andrey Glukhov - Brean Murray

Brad Reback - CIBC World Markets

Philip Alling - Bear Stearns

Alan Weinfeld - Henley & Company

Presentation

Operator

Good afternoon, ladies and gentlemen. My name is Pam, and I will be your conference operator today. At this time, I would like to welcome everyone to the JDA Software Third Quarter 2007 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to pose the question during this time, please press "*" then the "1" on your telephone keypad. If you would like to withdraw your question, press the "#" key. Thank you.

It is now my pleasure to turn the floor over to your host, Hamish Brewer, Chief Executive Officer. Sir, you may begin your conference.

Hamish Brewer - Chief Executive Officer

Thank you, Pam. Good afternoon and welcome to the earnings results call for the third quarter 2007. A record quarter for JDA, with revenues of $93 million and EBITDA of $25 million, along with year-over-year increases in software sales.

With me on the call today is Kris Magnuson, CFO and Executive Vice President of JDA. Kris will provide you with a detailed review of the third quarter and then I'll discuss the key trends in our business. After which I'll open up the call for questions.

So first, I'd like to hand it over to Kris.

Kris Magnuson - Chief Financial Officer and Executive Vice President

Thank you, Hamish, good afternoon, everyone. Our actual results may differ materially from those projected in forward-looking statements. Additional information concerning factors that could cause our actual results to materially differ from those in the forward-looking statements may be found in our Form 10-K for the year ended December 31, 2006 and other SEC filings.

Furthermore, this presentation includes 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 investors in evaluating JDA's ongoing business results. We have prepared a reconciliation of each of these measures to the most directly comparable GAAP measures in our press release which will be posted on our website at www.jda.com.

Today, we reported non-GAAP earnings per share of $0.40 for the third quarter of 2007 which compares to $0.31 in the second quarter of 2007 and $0.20 in the third quarter of 2006.

GAAP net income per share was $0.24 in the third quarter of '07 compared to $0.14 in the second quarter of '07 and a net loss of $0.38 a share in the third quarter of '06.

GAAP net income includes $5.5 million and $5.4 million in amortization of intangibles and $2.3 million and $84,000 in stock-based compensation in the third quarter of '07 and third quarter of '06 respectively.

GAAP net income in the third quarter of '06 also includes restructuring charges of $3.5 million, a $10.9 million adjustment to increase the carrying amount of the Series B Preferred Stock to its redemption value and a $1.1 million charge for a change in the fair value of the Series B Preferred Stock conversion feature.

Total revenues increased 3% to $93.6 million in the third quarter of '07 compared to $90.8 million in the second quarter of '07, and increased 5% from $89.2 million in the third quarter of '06.

Total revenues in the third quarter of '07 and the second quarter of '07 include $43.4 million and $39.8 million respectively from the manage of six product lines.

Adjusted operating income was $22.9 million or 24% of total revenues compared to $17.6 million or 19% of total revenues in the second quarter of '07, and $13.5 million or 15% last year.

We generated $25.3 million in adjusted EBITDA in the third quarter of '07 compared to $20.9 million in the second quarter of '07, $19.6 million in the third quarter of '07, $15.8 million in the fourth quarter of '06 and $15.7 million in the third quarter of '06. We have now owned Manugistics for a full year in our operations.

Year-over-year in the third quarter, our software sales were up 25% or $1.9 million in the Americas region and up 9% or $326,000 in Europe. Asia-Pac software was off $538,000 year-over-year.

The Manu product lines performed well this quarter with a $5.2 million overall contribution to software license revenue which represents a 62% increase year-over-year.

In the last 12 months, all regions have experienced organic software growth which resulted in a 47% growth worldwide.

Maintenance revenues increased 2% to $43.8 million in the third quarter compared to $43 million in the second quarter of '07 and increased 2% from $42.9 million in the third quarter of '06.

Foreign exchange rate variances provided a $339,000 benefit to the third quarter of '07 revenues as compared to $330,000 in the second quarter of '07 and a $1 million benefit when compared to the third quarter of '06.

On average, our annualized attrition rate is 5.7% year-to-date through September 30, 2007. This attrition was offset by the addition of $1.1 million in new maintenance streams from the second quarter software sales, rate increases on annual renewals and reinstatement of previously canceled maintenance agreements.

Maintenance margins were 74% in the third quarter of '07 compared to 73% in the second quarter of '07 and 79% in the third quarter of last year. The decrease in margin rates year-over-year is primarily the result of a 15% increase in average headcount and a $581,000 increase in incentive compensation. The sequential improvement in margin rates is attributed to a decrease in third-party royalty and agent fees which drop $270,000 or 15% during the third quarter.

During the second quarter, we incurred approximately a $144,000 in one-time charges related to certain previously unidentified royalty obligations. We ended the third quarter of '07 with 262 employees in our support organization compared to 263 at the second quarter of '07 and 243 in the third quarter of '06. We are not expecting any significant changes in our support headcount in the fourth quarter of 2007.

Total services revenue increased $5.2 million or 18% to $34.4 million in the third quarter compared to $29.2 million in the second quarter of '07 and 6% from the $32.5 million in the third quarter of last year.

Our service margins improved to 30% in the third quarter of '07 compared to 21% in the second quarter and 23% in the third quarter of last year. The increase in service revenues and service margins in the third quarter is due primarily to the release of approximately $3.4 million in previously deferred consulting revenue and customer liabilities upon the successful completion and final acceptance of a fixed bid project inherited from Manugistics.

This project contained a refund right that extended through final acceptance, therefore all revenue had been deferred until final acceptance by the customer. The net impact of this project on our service margins was $2 million after realizing the deferred costs associated with the project.

Other factors contributing to the increase in our CSG revenues were an increase in worldwide utilization to 57% in the third quarter of '07 compared to 51% last quarter and 45% last year.

We ended the third quarter of '07 with 433 employees in our services department compared to 455 at the end of the second quarter and 516 at the end of the third quarter last year.

We expect our fourth quarter services margin to be more in line with our year-to-date average in '07 which smooths out the impact of the acceptance revenue that was received and recognized in the third quarter for work that was done over several prior quarters.

Product development expense was flat sequentially at $11.9 million in the third quarter and decreased $4.9 million or 29% compared to the third quarter of last year. The year-over-year decrease is primarily due to a 15% decrease in average headcount which resulted in a $3.3 million decrease in salary and related benefits.

In addition, we deferred $1.2 million of costs related to ongoing funded development efforts that was offset in part by an $800,000 increase in incentive compensation due to the company's improved operating performance.

We ended the third quarter of '07 with 446 people in product development compared to 412 at the end of the June quarter '07 and 546 at the end of the third quarter last year.

Our sales and marketing expense was flat sequentially at $15 million in the third quarter compared to the second quarter of '07 and increased $1.4 million or 10% compared to the third quarter of last year. The year-over-year increase is primarily due to higher internal and external third-party commissions resulting from the 13% increase in software sales, as well as a $625,000 increase in restricted stock expense and increased travel costs.

We ended the third quarter with 222 people in sales and marketing compared to 208 at the end of the second quarter in '07 and 219 at the end of the third quarter last year. These numbers include quota-carrying sales associates of 69, 64 and 65 respectively. We expect this expense line to be up sequentially in the fourth quarter due to year end accelerators on sequentially higher software performance and the seasonal timing of certain marketing activities.

General and administrative expense was flat sequentially and year-over-year at $10.4 million. In the third quarter of '07 we recorded a $1.2 million increase in incentive comp compared to the third quarter of last year including $1 million in restricted stock plan expense primarily related to the Manugistics integration incentive plan. These increases were offset in part by a $479,000 decrease in legal costs and a $300,000 favorable FX swing year-over-year. We ended the third quarter of '07 with 208 people in G&A functions compared to 217 at the end of the second quarter of '07 and a 199 at the end of the third quarter of '06.

Other than potential fluctuations in bad debt expense, foreign exchange gains or losses, and variable compensation expense, we expect our overall cost structure in the fourth quarter of 2007 to be consistent with that of the third quarter of 2007.

We ended the third quarter of '07 with $82.6 million in cash, up from $65.4 million at the end of the second quarter. During the third quarter of '07, we received over $90 million in cash collections and paid off $4.6 million of debt, leaving a net debt balance or gross debt balance of $101.5 million, of which $3.3 million is current, $1.5 million of the current debt relates to Manugistics subordinated debentures that were never tendered.

The subordinated debentures mature and will be paid out in November of 2007. We generated $20.4 million in cash flow from operations in the third quarter compared with $24.9 million in the second quarter and $18.4 million in the first quarter of '06. And overall, our day sales outstanding dropped back to normal levels of 68 days.

And with that, I'll turn it back over to Hamish.

Hamish Brewer - Chief Executive Officer

Thank you, Kris. The third quarter delivered further progress for JDA. Our operating model continues to strengthen with an impressive 27% EBITDA margin and cash flow from operations providing a healthy $20 million contribution to our strengthening balance sheet.

Fundamentally, the business is financially very healthy, and we're delivering strong results across all major aspects of the business, and I'd like to take the opportunity to highlight these strengths.

Firstly, software sales continue to improve with a 13% year-over-year growth, and bear in mind that we're now comparing like-for-like post-Manugistics acquisition results. Although we had a sequential decline over the second quarter , I am not at all concerned about this. As very often the third quarter is the softest quarter for JDA.

As I look at our pipeline of opportunity, I see a strong pipeline for the fourth quarter. In fact, I was reviewing our historic internal forecast recently and this is only the third time since the year 2000 that we've had a similarly strong pipeline at the start of any quarter, so why has this happened?

First of all, I believe that the acquisition of Manugistics catapulted JDA to a new level of performance and profile in the marketplace. On the one hand we continue to achieve excellent win rates in our Heritage Market Tier 2, but additionally, we're now recognized as the only credible supply chain planning and optimization focused company for Tier 1, where the industry heavyweights, Oracle and SAP should arguably have their greatest advantage over JDA.

In this important sector of our business, we're competing toe-to-toe with these companies and many others and maintaining an excellent win rate. I believe this win rate is attributable firstly to our deep industry focus, delivering innovative solutions that yield superior results and have been proven second to none in Tier 1 scalability and performance, and secondly, to our people, who provide superior added value and experience to our customers' projects.

Next, our performance in maintenance services remains very strong. As more and more companies are being forced by SEC guidelines to expose their true maintenance revenues, it's clear which companies are actually primarily software companies with customers taking upgrades and obtaining value for maintenance revenues and which companies focus primarily on highly customized services driven customer projects.

The customers of those companies obtain little to no value for maintenance services and ultimately in my view, this business model is not scalable. Our continued high maintenance retention rate which has been consistent for many years is further proof that JDA customers are receiving significant value from JDA support services.

Thirdly, our performance in consulting services is starting to improve. As we indicated earlier this year, this is the part of our business that's taken the longest to truly integrate post-Manu acquisition, but I think we're starting to see that turnaround as we predicted.

We did receive a sizeable performance bonus from a major project that we inherited from Manu that we've been working on all year. The effect of this project has been to depress our consulting margins in the first two quarters and inflate them this quarter; however, even without this lift, our consulting margins would have increased to 27% in the third quarter from 21% in the second quarter.

We expect this underlying improvement to continue, although we will experience the usual downturn in the fourth quarter due to the normal seasonal loss in utilization from the holidays.

So to reiterate, I feel the business is performing well, we are winning new business, both in our existing customer base and with new customers. In fact, year-to-date, 36% of our license sales have come from new customers and 64% have come from existing customers, but in either case, we are typically competing for this business and beating the same competitors.

With regard to our full year guidance that we updated in July, I'd like to briefly review our year-to-date position. We provided year end guidance of $65 million to $75 million of software revenue and at the 9 month point, we're at $51.2 million which puts us at 73% of the mid point of our range.

Total revenues regarded as $353 million to $371 million and as the 9 month, the end of the third quarter we're at 76% of the mid point of that range.

As far as EBITDA is concerned, we guided $75 million to $85 million, and at the end of the third quarter, we're at 82% of the mid point of that range.

Adjusted EPS, we're at 84% of the mid point of the range we provided which was a $1.10 to $1.25, and finally GAAP EPS we provided a range of $0.56 to $0.72 and at the end of the third quarter, we're at 86% of the mid point of that range.

So based on these results, you could see that we are trending well towards the high end of our revenues and are well positioned to beat our guidance on total earnings. Where we end up will depend primarily on our software performance, about which as I said earlier we feel very confident right now, so you can tell we feel very good about how this year is unfolding.

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

Question-and-Answer Session

Operator

Thank you. At this time I would like to remind everyone, if you would like to pose a question, please press "*" then the "1" on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question is coming from Andrey Glukhov with Brean Murray. Please go ahead.

Andrey Glukhov - Brean Murray

Yes, thanks. Kris, on the consulting services margin so directionally, it sounds like you made some structural underlying further improvements in the consulting organization. Should we expect that to continue to improve into next year or is that 27% lower that Hamish cited about the right number?

Kris Magnuson - Chief Financial Officer and Executive Vice President

So we're still working on our full year budget for 2008, but we have a lot of the non-billable work that we inherited from Manugistics officially behind us now, and so I think kind of our floor is now probably the 27%, except for having the impact of Thanksgiving and Christmas in the fourth quarter, it probably will push on us to the tune of about 2 points, but I would think we're in good shape as we enter 2008 to stay in the mid to upper 20% throughout 2008.

Andrey Glukhov - Brean Murray

Okay, and to be clear, are there any additional contracts of that magnitude that you inherited from Manugistics that you still need to work your way through?

Kris Magnuson - Chief Financial Officer and Executive Vice President

No, we have, there's one small one left in South Africa, but everything else is behind us now. We've completed all but one project and that one is not significant to our operation.

Andrey Glukhov - Brean Murray

Okay, and then Hamish, you sound very optimistic about the pipeline. Any early thoughts on what the demand, what I guess the demand from retailers would look like in light of sort of recent weakness under consumer spending, how would that affect the demand past the upcoming quarter?

Hamish Brewer - Chief Executive Officer

Yeah, that's obviously something that we've been looking at pretty carefully for any signs there. I can say that in the third quarter, we had one customer cite nervousness about the overall economic conditions and it partially impacted a deal away, they cut the deal in half and we only did one piece of it instead of the whole thing.

But out of the total number of deals that we did in the whole quarter, that's kind of the level we're at, just one or two small data points. Now, I wouldn't say that there's anything like a significant trend at this point, pointing us towards a concern about the macroeconomic conditions in terms of the buying market for our software. Conversely, as I said, we're actually are seeing very strong pipeline activity right now.

Andrey Glukhov - Brean Murray

Okay, and then lastly, now that you had the Manugistics acquisition anniversaried and presumably sort of all the heavy lifting is done, can you review with us any I guess thoughts about future M&A activity? Thank you.

Hamish Brewer - Chief Executive Officer

Yeah, I think the company is well positioned now to be very seriously looking out there in the marketplace. The good news is there are some good opportunities out there and while you can never really plan for exactly when these things are going to happen, I can assure you that we're working on that actively as we speak.

Andrey Glukhov - Brean Murray

Okay, great. Thank you.

Hamish Brewer - Chief Executive Officer

Thanks.

Operator

Thank you. Your next question is coming from Brad Reback with CIBC World Markets. Please go ahead.

Brad Reback - CIBC World Markets

Hi, guys, how are you?

Hamish Brewer - Chief Executive Officer

Hi, Brad. Very well, thanks.

Brad Reback - CIBC World Markets

Hamish, with the decline in DSOs to the lowest point several quarters especially since the Manu deal, should we look at that and say maybe there wasn't a whole lot of rush at the end of the quarter to get the license number done?

Hamish Brewer - Chief Executive Officer

Well, I think that the biggest impact really there was the work that we've been doing all year on maintenance collections. We went through this whole process in the first quarter of issuing maintenance renewals to the Manugistics base, a lot of which were timed around the year end which was the end of February.

And then we subsequently in the second quarter had a lot of situations where we basically put accounts on reserve, because we basically hold back the revenue if the invoice isn't paid past 60 days.

We're pretty disciplined about doing that and then I think what's happened is we've really been working now for the last four or five months on really working our way through that and improving our processes, so that we can try to smooth out our revenue renewal process going forward. And I think that that's starting to pay off. So I think maintenance has really been the prime driver of that reduction in the DSOs overall.

Kris Magnuson - Chief Financial Officer and Executive Vice President

I would say this quarter with respect to software licenses was typically back end loaded as most quarters.

Hamish Brewer - Chief Executive Officer

Yeah. In fact, third quarter is quite frankly, is usually the worst one because we have to basically do it all in September.

Brad Reback - CIBC World Markets

Okay, that's very helpful. Kris, on the deferral of some of the funded R&D, how much longer does that go on for?

Kris Magnuson - Chief Financial Officer and Executive Vice President

Most of those projects are going to be finished up by the end of this year, although we are actively working with other customers to get new funded development projects set up for 2008, so we always have a level of it going on.

Brad Reback - CIBC World Markets

And how will that impact the P&L once those projects are done? Well that be an increase in R&D as related to those projects?

Kris Magnuson - Chief Financial Officer and Executive Vice President

Well, a lot of it we have control over because we flex up our base using outside contractors, so we'll have the ability to contain our costs.

Brad Reback - CIBC World Markets

Okay. That's great. That's all I have. Thank you.

Hamish Brewer - Chief Executive Officer

Thanks, Brad.

Operator

Thank you. Your next question is coming from Philip Alling with Bear Stearns. Please go ahead.

Philip Alling - Bear Stearns

Thanks much, yes. I just wanted to get a sense from you as far as the release on the preferred, the deferred consulting revenue. Had it been your expectation that that was going to occur this calendar year and --?

Kris Magnuson - Chief Financial Officer and Executive Vice President

Well, to be quite honest, we weren't sure we were going to hit the performance bonus, so we thought we would at least collect enough to cover our cost and so we've been deferring the cost and deferring the offsetting revenue that we expected to receive from the customer, but there was a performance bonus associated with the successful completion of this project that until our Performance Engineering Group and a bunch of other bright people got out there and really worked on the project, we weren't sure we were going to get it.

Hamish Brewer - Chief Executive Officer

This was -- just to give you a little bit more color on it, this was a case in point where a large Tier 1 company was pushing us to drive volumes through the Manu applications in a retail environment that had never been done before. And the great news out of the back of it is that we've now got a benchmark which shows our ability to scale to unprecedented levels in Tier 1.

Philip Alling - Bear Stearns

With respect to Manugistics perhaps a bit more color as far as the license performance. You did post better growth in the Americas and in Europe on the Manugistics solution so perhaps you could help us better understand what was driving that?

And then also, would want to better understand the relative weakness in the license sales for your core products, the core JDA solutions in those same regions in North America and Europe, as well as in Asia Pacific also for the JDA Solutions so perhaps you could help us better understand that?

Kris Magnuson - Chief Financial Officer and Executive Vice President

Well, first of all, I think you have to look at it more than one quarter at a time because we don't have a 90-day business, so you really need to look at this over a period of time. And both the Americas, JDA products and the European products are up year-over-year on the core business.

We have had some organizational issues in a lot of turnover in our sales force in Asia Pacific which we're focused on, but luckily, the Manugistics new products have been making up the difference there.

So we really see ourselves as one business now because demand didn't fulfill and E-3 Classic had a lot of overlap, so it's really I think you have to look at the entire portfolio and what's going on there and the overall increase in demand on a total basis within our customer base.

Hamish Brewer - Chief Executive Officer

Yes, I mean I think overall we feel pretty good about how the core JDA business, if you like, is trending. It goes up and down from quarter-to-quarter and as I said third quarter is quite often a soft quarter for us, but I don't think there's any underlying trend that you should read into that.

We feel pretty good about where it's headed for the year and then layered on top of that I think what we're seeing is definitely the revitalization of the Manugistics business. It's really coming back to I'd say it's former glory.

Philip Alling - Bear Stearns

And just the final question for me then just would be with respect to the large deal pipeline, the supplemental data that you provided to indicate that you didn't have any deals north of a $1million in this quarter. Could you just give us a sense about what investor expectations should be with regarding large deals on a going forward basis?

Hamish Brewer - Chief Executive Officer

Well, I can tell you we've got a nice stack of them lined up for the fourth quarter, so as I say, they bounce up and down from quarter-to-quarter. You can't really, I've never seen any indication of a real sort of strong trend one way or another on a 90-day basis. So the fact that we didn't have any in this quarter I don't think means anything like it didn't mean anything in the first quarter. And I think right now, it looks promising that we should have a good number of them in the fourth quarter.

Philip Alling - Bear Stearns

Excellent. I appreciate that. Thanks much.

Hamish Brewer - Chief Executive Officer

No problem.

Operator

Thank you. Once again, if you would like to pose a question, you may press "*" followed by the "1" on your touchtone phone at this time. Thank you. Your next question is coming from Alan Weinfeld with Henley & Company. Please go ahead.

Alan Weinfeld - Henley & Company

Hi. I was just wondering if you seen any effect in the quarter from I call the ankle biters some of these guys, they're small but have gotten some capital, but they have in fact went public I think in the recent quarter and some other companies that were really small have been scooped up by bigger companies like I think, Commercialware had a decent offering and was picked up by Micros probably a year ago, year and a half ago in the POS area. Have you seen anything different competitively from some of these small guys maybe getting more capitalized?

Hamish Brewer - Chief Executive Officer

Not really to be honest with you. I'd say overall, we continue to see a trend in the marketplace where certainly, there are point solution competitors are still, if you like good competitors for JDA out there in the marketplace, haven't disappeared all together. But the trend compared with let's say five years ago, there's many less than there were that were really effective competitors.

And let's take for example, a company like Evant. Evant was a good competitor of JDA, and we would go into battle with them regularly and they were a tough company to beat and ever since they've been acquired by Manhattan, they pretty much disappeared off the map as far as we're concerned. So it's not always a good thing when they get I think more capital behind them. It depends on whether the company that has bought them knows what they're going to do with it. And I'd say in a lot of cases, it doesn't seem to really translate into additional competitive presence for those small companies.

Alan Weinfeld - Henley & Company

But do you have partnerships with any of these analytic spenders that might possibly be acquired by Oracle or are already acquired by Oracle that might be affected?

Hamish Brewer - Chief Executive Officer

Well, the main analytic product that we resell is [Cognos], so I can't speak for Oracle's plans to acquire [Cognos] or not, but that's the main company that we partner with.

Alan Weinfeld - Henley & Company

Thank you.

Hamish Brewer - Chief Executive Officer

Pleasure.

Operator

Thank you. Mr. Brewer, there appears to be no further questions at this time. I'd like to turn the floor back over to you for closing comments.

Hamish Brewer - Chief Executive Officer

Okay, Pam, well thank you very much for attending the call. I look forward to catching up with you in January, giving you our year end results and until then, take care. Thanks.

Operator

Thank you. And this concludes today's JDA Software Group's third quarter 2007 earnings conference call. You may now disconnect your lines, and have a pleasant afternoon.

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