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JDA Software Group Inc. (NASDAQ:JDAS)

Q3 2007 Earnings Call

October 22, 2007 4:45 pm ET

Executives

Hamish Brewer - Chief Executive Officer

Kris Magnuson - Chief Financial Officerand Executive Vice President

Analysts

Andrey Glukhov - Brean Murray

Brad Reback - CIBC World Markets

Philip Alling - Bear Stearns

Alan Weinfeld - Henley &Company

Operator

Good afternoon, ladies andgentlemen. My name is Pam, and I will be your conference operator today. Atthis time, I would like to welcome everyone to the JDA Software Third Quarter2007 Earnings Conference Call. All lines have been placed on mute to preventany background noise. After the speakers' remarks, there will be a question-and-answerperiod. If you would like to pose the question during this time, please press"*" then the "1" on your telephone keypad. If you wouldlike to withdraw your question, press the "#" key. Thank you.

It is now my pleasure to turn thefloor over to your host, Hamish Brewer, Chief Executive Officer. Sir, you maybegin your conference.

Hamish Brewer - Chief Executive Officer

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

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

So first, I'd like to hand itover to Kris.

Kris Magnuson - Chief Financial Officer and Executive Vice President

Thank you, Hamish, goodafternoon, everyone. Our actual results may differ materially from those projectedin forward-looking statements. Additional information concerning factors thatcould cause our actual results to materially differ from those in theforward-looking statements may be found in our Form 10-K for the year endedDecember 31, 2006 and other SEC filings.

Furthermore, this presentationincludes non-GAAP measures which JDA uses internally in budgeting andperformance monitoring activities to gauge our business performance. We believethese measures provide useful information to investors in evaluating JDA'songoing business results. We have prepared a reconciliation of each of thesemeasures to the most directly comparable GAAP measures in our press releasewhich will be posted on our website at www.jda.com.

Today, we reported non-GAAPearnings 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 '07and a net loss of $0.38 a share in the third quarter of '06.

GAAP net income includes $5.5million 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 thirdquarter of '06 respectively.

GAAP net income in the thirdquarter of '06 also includes restructuring charges of $3.5 million, a $10.9million adjustment to increase the carrying amount of the Series B PreferredStock to its redemption value and a $1.1 million charge for a change in thefair 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 thesecond quarter of '07, and increased 5% from $89.2 million in the third quarterof '06.

Total revenues in the thirdquarter of '07 and the second quarter of '07 include $43.4 million and $39.8million 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% oftotal revenues in the second quarter of '07, and $13.5 million or 15% lastyear.

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

Year-over-year in the thirdquarter, our software sales were up 25% or $1.9 million in the Americasregion and up 9% or $326,000 in Europe. Asia-Pacsoftware was off $538,000 year-over-year.

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

In the last 12 months, allregions have experienced organic software growth which resulted in a 47% growthworldwide.

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

Foreign exchange rate variancesprovided 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 tothe third quarter of '06.

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

Maintenance margins were 74% inthe 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-yearis primarily the result of a 15% increase in average headcount and a $581,000increase in incentive compensation. The sequential improvement in margin ratesis attributed to a decrease in third-party royalty and agent fees which drop $270,000or 15% during the third quarter.

During the second quarter, weincurred approximately a $144,000 in one-time charges related to certainpreviously unidentified royalty obligations. We ended the third quarter of '07with 262 employees in our support organization compared to 263 at the secondquarter of '07 and 243 in the third quarter of '06. We are not expecting anysignificant 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 $29.2million in the second quarter of '07 and 6% from the $32.5 million in the thirdquarter of last year.

Our service margins improved to30% 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 servicemargins in the third quarter is due primarily to the release of approximately$3.4 million in previously deferred consulting revenue and customer liabilitiesupon the successful completion and final acceptance of a fixed bid projectinherited from Manugistics.

This project contained a refundright that extended through final acceptance, therefore all revenue had beendeferred until final acceptance by the customer. The net impact of this projecton our service margins was $2 million after realizing the deferred costsassociated with the project.

Other factors contributing to theincrease 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 '07with 433 employees in our services department compared to 455 at the end of thesecond quarter and 516 at the end of the third quarter last year.

We expect our fourth quarterservices margin to be more in line with our year-to-date average in '07 whichsmooths out the impact of the acceptance revenue that was received andrecognized in the third quarter for work that was done over several priorquarters.

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

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

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

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

We ended the third quarter with222 people in sales and marketing compared to 208 at the end of the secondquarter in '07 and 219 at the end of the third quarter last year. These numbersinclude quota-carrying sales associates of 69, 64 and 65 respectively. Weexpect this expense line to be up sequentially in the fourth quarter due toyear end accelerators on sequentially higher software performance and theseasonal timing of certain marketing activities.

General and administrative expensewas flat sequentially and year-over-year at $10.4 million. In the third quarterof '07 we recorded a $1.2 million increase in incentive comp compared to thethird quarter of last year including $1 million in restricted stock planexpense primarily related to the Manugistics integration incentive plan. Theseincreases 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 '07with 208 people in G&A functions compared to 217 at the end of the secondquarter of '07 and a 199 at the end of the third quarter of '06.

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

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

The subordinated debenturesmature and will be paid out in November of 2007. We generated $20.4 million incash flow from operations in the third quarter compared with $24.9 million inthe 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 backover to Hamish.

Hamish Brewer - Chief Executive Officer

Thank you, Kris. The thirdquarter delivered further progress for JDA. Our operating model continues tostrengthen with an impressive 27% EBITDA margin and cash flow from operationsproviding a healthy $20 million contribution to our strengthening balancesheet.

Fundamentally, the business isfinancially very healthy, and we're delivering strong results across all majoraspects of the business, and I'd like to take the opportunity to highlightthese strengths.

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

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

First of all, I believe that theacquisition of Manugistics catapulted JDA to a new level of performance andprofile in the marketplace. On the one hand we continue to achieve excellentwin rates in our Heritage Market Tier 2, but additionally, we're now recognizedas the only credible supply chain planning and optimization focused company forTier 1, where the industry heavyweights, Oracle and SAP should arguably havetheir greatest advantage over JDA.

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

Next, our performance inmaintenance services remains very strong. As more and more companies are beingforced by SEC guidelines to expose their true maintenance revenues, it's clearwhich companies are actually primarily software companies with customers takingupgrades and obtaining value for maintenance revenues and which companies focusprimarily on highly customized services driven customer projects.

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

Thirdly, our performance inconsulting 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 integratepost-Manu acquisition, but I think we're starting to see that turnaround as wepredicted.

We did receive a sizeableperformance bonus from a major project that we inherited from Manu that we'vebeen working on all year. The effect of this project has been to depress ourconsulting margins in the first two quarters and inflate them this quarter;however, even without this lift, our consulting margins would have increased to27% in the third quarter from 21% in the second quarter.

We expect this underlyingimprovement to continue, although we will experience the usual downturn in thefourth quarter due to the normal seasonal loss in utilization from theholidays.

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

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

Total revenues regarded as $353 millionto $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, weguided $75 million to $85 million, and at the end of the third quarter, we'reat 82% of the mid point of that range.

Adjusted EPS, we're at 84% of themid point of the range we provided which was a $1.10 to $1.25, and finally GAAPEPS 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, youcould see that we are trending well towards the high end of our revenues andare well positioned to beat our guidance on total earnings. Where we end upwill depend primarily on our software performance, about which as I saidearlier we feel very confident right now, so you can tell we feel very goodabout how this year is unfolding.

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

Question-and-Answer Session

Operator

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

Andrey Glukhov - Brean Murray

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

Kris Magnuson - Chief Financial Officer and Executive Vice President

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

Andrey Glukhov - Brean Murray

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

Kris Magnuson - Chief Financial Officer and Executive Vice President

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

Andrey Glukhov - Brean Murray

Okay, and then Hamish, you soundvery optimistic about the pipeline. Any early thoughts on what the demand, whatI guess the demand from retailers would look like in light of sort of recentweakness under consumer spending, how would that affect the demand past theupcoming quarter?

Hamish Brewer - Chief Executive Officer

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

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

Andrey Glukhov - Brean Murray

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

Hamish Brewer - Chief Executive Officer

Yeah, I think the company is wellpositioned now to be very seriously looking out there in the marketplace. Thegood news is there are some good opportunities out there and while you cannever really plan for exactly when these things are going to happen, I canassure 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 iscoming 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 DSOsto the lowest point several quarters especially since the Manu deal, should welook at that and say maybe there wasn't a whole lot of rush at the end of thequarter to get the license number done?

Hamish Brewer - Chief Executive Officer

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

And then we subsequently in thesecond quarter had a lot of situations where we basically put accounts onreserve, because we basically hold back the revenue if the invoice isn't paidpast 60 days.

We're pretty disciplined aboutdoing that and then I think what's happened is we've really been working nowfor the last four or five months on really working our way through that andimproving our processes, so that we can try to smooth out our revenue renewalprocess going forward. And I think that that's starting to pay off. So I thinkmaintenance has really been the prime driver of that reduction in the DSOsoverall.

Kris Magnuson - Chief Financial Officer and Executive Vice President

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

Hamish Brewer - Chief Executive Officer

Yeah. In fact, third quarter isquite frankly, is usually the worst one because we have to basically do it allin 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 onfor?

Kris Magnuson - Chief Financial Officer and Executive Vice President

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

Brad Reback - CIBC World Markets

And how will that impact theP&L once those projects are done? Well that be an increase in R&D asrelated to those projects?

Kris Magnuson - Chief Financial Officer and Executive Vice President

Well, a lot of it we have controlover because we flex up our base using outside contractors, so we'll have theability to contain our costs.

Brad Reback - CIBC World Markets

Okay. That's great. That's all Ihave. Thank you.

Hamish Brewer - Chief Executive Officer

Thanks, Brad.

Operator

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

Philip Alling - Bear Stearns

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

Kris Magnuson - Chief Financial Officer and Executive Vice President

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

Hamish Brewer - Chief Executive Officer

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

Philip Alling - Bear Stearns

With respect to Manugisticsperhaps a bit more color as far as the license performance. You did post bettergrowth in the Americas and in Europeon the Manugistics solution so perhaps you could help us better understand whatwas driving that?

And then also, would want tobetter understand the relative weakness in the license sales for your coreproducts, 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 helpus better understand that?

Kris Magnuson - Chief Financial Officer and Executive Vice President

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

We have had some organizationalissues in a lot of turnover in our sales force in Asia Pacific which we'refocused on, but luckily, the Manugistics new products have been making up thedifference there.

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

Hamish Brewer - Chief Executive Officer

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

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

Philip Alling - Bear Stearns

And just the final question forme then just would be with respect to the large deal pipeline, the supplementaldata 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 investorexpectations should be with regarding large deals on a going forward basis?

Hamish Brewer - Chief Executive Officer

Well, I can tell you we've got anice stack of them lined up for the fourth quarter, so as I say, they bounce upand down from quarter-to-quarter. You can't really, I've never seen anyindication 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 meansanything like it didn't mean anything in the first quarter. And I think rightnow, it looks promising that we should have a good number of them in the fourthquarter.

Philip Alling - Bear Stearns

Excellent. I appreciate that.Thanks much.

Hamish Brewer - Chief Executive Officer

No problem.

Operator

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

Alan Weinfeld - Henley & Company

Hi. I was just wondering if youseen 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 Ithink in the recent quarter and some other companies that were really smallhave been scooped up by bigger companies like I think, Commercialware had adecent offering and was picked up by Micros probably a year ago, year and ahalf ago in the POS area. Have you seen anything different competitively fromsome 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 competitorsfor JDA out there in the marketplace, haven't disappeared all together. But thetrend compared with let's say five years ago, there's many less than there werethat were really effective competitors.

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

Alan Weinfeld - Henley & Company

But do you have partnerships withany of these analytic spenders that might possibly be acquired by Oracle or arealready acquired by Oracle that might be affected?

Hamish Brewer - Chief Executive Officer

Well, the main analytic productthat 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, thereappears to be no further questions at this time. I'd like to turn the floorback over to you for closing comments.

Hamish Brewer - Chief Executive Officer

Okay, Pam, well thank you verymuch 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 concludestoday's JDA Software Group's third quarter 2007 earnings conference call. Youmay now disconnect your lines, and have a pleasant afternoon.

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