Saba Software F4Q08 (Qtr End 5/31/08) Earnings Call Transcript

Saba Software, Inc. (SABA)

F4Q08 Earnings Call

July 16, 2008 5:00 pm ET

Executives

Bobby Yazdani - Chairman of the Board, Chief Executive Officer

Carol Rice-Murphy - Interim Chief Financial Officer

Analysts

Ryan Bergen - Craig-Hallum Capital

Ariel Sokol - Wedbush Morgan Securities

Kevin Liu - B. Riley & Company

Daniel Still - Z.F. Partners

Charles Frumberg - Analyst

James Bocsh - Dialectic Capital

Presentation

Operator

Ladies and gentlemen, thank you very much for standing by and welcome to your Saba fourth quarter fiscal year 2008 financial results. (Operator Instructions) And we’ll now turn the conference over to our host and Saba CFO, Carol Rice-Murphy. Please go ahead.

Carol Rice-Murphy

Thank you, Bob. Good afternoon and welcome to the Saba Software fourth quarter 2008 conference call. I’m Carol Rice-Murphy, Saba's Vice President of Finance and Interim CFO. Today we will discuss our financial results for the fourth quarter ended May 31, 2008. With me today is Chairman and Chief Executive Officer, Bobby Yazdani.

Before we begin, I would like to point out that certain remarks made in the course of this conference call are forward-looking statements. These statements included but are not limited to Saba's future performance and financial projections, Saba's ability to address international execution issues, anticipated evaluation from time to time of strategic transactions, Saba's ability to continue to scale and grow its business, expected availability of Saba's new and enhanced product offerings, including efforts to unveil people-centric collaboration, anticipated demand for and steady growth in Saba's on-demand business, Saba's intent to focus on cross-selling and up-selling its global customer base, Saba's ability to expand product use in existing customer accounts and win new enterprise deals, expected cash from operations in fiscal year 2009, Saba's ability to increasingly generate new types of business from initiatives to expand informal learning and collaboration, and Saba's ability to increase the percentage of revenues from indirect channels and to add new key distribution partners to support this effort.

These statements are based solely on information available to us today, reflect management’s current expectations and beliefs, and are subject to numerous risks and uncertainties. It’s important to note that our actual results could differ materially from those contained in such forward-looking statements. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in our annual report on Form 10-K for the year ended May 31, 2007, and similar disclosures in subsequent Saba periodic SEC reports. Copies of these reports may be obtained from the SEC. We disclaim any duty to update such statements.

In addition, we intend to discuss today both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP results is included with the financial statements accompanying our earnings release and is available on our website at www.saba.com. Saba's management believes that non-GAAP information is an additional meaningful measure of operating performance because it measures the principal operating results that can be directly influenced by management and provides more consistent comparability to our financial results against historical results and the reported results of other software companies.

Before I jump into those financial results for the quarter, let me turn the call over to Bobby, who will speak to you on the general state of our business. I will discuss our expectations for 2009 later in the call.

Bobby Yazdani

Thanks, Carol. Let me start by giving you color on our Q4 results. The overall bookings remained quite healthy. Total bookings were around $29 million for the fourth quarter. Product bookings were evenly split between license and on-demand offerings. We signed a number of important contracts with new and existing customers during the quarter, including Cisco, NCR, Nissan, Time-Warner Telecom, Toto Corporation, and University of Tennessee.

While North America continued to deliver strong results, we experienced execution issues in our international business, which we are addressing. A number of international contracts which did not close during the Q4 closed earlier in Q1.

During the quarter, we also evaluated a strategic transaction which did not come to fruition. This impacted our GAAP results by $0.01. While this opportunity is no longer viable, we do expect to evaluate from time to time options to scale Saba's business and enhance our shareholders’ value.

Let me reiterate our top priorities for Saba; maintaining our leadership in the human capital enterprise market, profitable growth, generating cash, and building our recurring revenue streams. We have made great progress toward all of these objectives. During fiscal 2008, we achieved a number of our financial milestones. During the year, we generated over $5 million cash from operations and our recurring revenue streams grew 13% year over year. We signed over 100 new customers, extending our leadership in the human capital enterprise market.

Based on our current revenue and cost forecast for 2009, we believe we can generate EBITDA net margins of 10% to 15%, and possibly higher net margins as we continue to scale and grow the business.

We are confirming the current estimates for fiscal 2009 of approximately $111 million of revenue and non-GAAP earnings of $0.25.

Let me now turn it over to Carol to review the financial results.

Carol Rice-Murphy

Thanks, Bobby. Now for those financial results -- total revenues in the fourth quarter of fiscal 2008 were $27.7 million, an increase of about 8% from the fourth quarter 2007 on a GAAP basis, but below our guidance. As Bobby indicated, we experienced execution issues in our international business.

In the fourth quarter, we added 20 new customers and completed 77 license and 75 on-demand deals in the period. U.S. revenue represented 75% of total revenue, consistent with recent quarters.

License revenue in the fourth quarter totaled $5.6 million. This is up 11% from the prior year fourth quarter of $5 million and 7% below the $6 million in the preceding quarter. On-demand revenue totaled $4.7 million, 8% higher than in the same quarter of 2007 at $4.3 million and up slightly from 4.6 in the prior quarter. We continue to see traction in our on-demand business and believe that it will build steadily in the coming quarters.

Product revenue from the sale of licenses and on-demand solutions represented 37% of total revenue. A rough breakout of product bookings for fiscal year 2008 would be 50% learning, 40% center collaboration, and the remainder 10% performance and talent.

License updates and product support revenue in the fourth quarter of 2008 totaled $8.8 million, an increase of 6% compared to the same quarter last year and up 4% from the prior quarter. Our recurring revenue streams, the combination of on-demand and license updates and product support, represented 49% of total. The current breakdown of our revenue on the income statement is approximately 83% license and license related and 17% on-demand.

New business booked in the fourth quarter was about 72% license and license related and 28% on-demand. At $8.6 million, professional service revenue increased 9% from the fourth quarter of fiscal 2007 and 3% over the prior quarter. Overall gross margins were 61% in the fourth quarter, down slightly from 62% recorded in the fourth quarter 2007 and down from the 63% we recorded in the preceding quarter of 2008. Much of this was influenced by lower license revenue mix, as well as lower on-demand margins as we continue to invest in support of demand.

Included in gross margin is approximately $300,000 of intangible amortization and stock-based compensation of approximately $100,000.

In summary, our margins for the fourth quarter were as follows: license gross margin at 96%, license updates and product support gross margin at 74%, on-demand gross margin at 52%, professional services gross margin at 33%.

Our fourth quarter sales and marketing costs were $8.4 million, or 30% of revenue, which was in line with our expectations, consistent with the prior quarter, and significantly lower than the $10.4 million incurred in the fourth quarter of 2007. This reduction reflects the actions taken earlier this year, which reduced our annualized sales and marketing run-rate by over $6 million.

Total operating expenses were $17.1 million in the fourth quarter of fiscal 2008, well below the $19.1 million recorded in the fourth quarter 2007, and slightly above $16.8 million in the prior quarter. This increase resulted primarily from expenses incurred in connection with the evaluation of the strategic transaction that did not materialize. Total operating expenses in the fourth quarter of fiscal 2008 included amortization of purchased intangible assets of $600,000 and stock-based comp of $400,000.

Total depreciation expense for the quarter was approximately $550,000.

On a GAAP basis, our net loss for the quarter improved to $603,000, or $0.02 per share from a net loss of $3.1 million, or $0.11 per share in the fourth quarter of 2007. Non-GAAP net income and earnings per share increased to $1.5 million, or $0.05 per share on a basic and diluted basis in the quarter, from a non-GAAP net loss of $1.4 million, or $0.05 per share in the fourth quarter of fiscal year 2007.

We ended the fourth quarter with $31.3 million of deferred revenue, a 6% increase from the fourth quarter 2007, down slightly from $32.2 million at the end of last quarter. This third quarter historically includes high renewals for maintenance and on-demand customers.

The breakdown of our deferred revenue by category is as follows: for the fourth quarter 2008, 2% deferred revenue was from license; 58% from license updates and product support; 31% from on-demand; and 9% from professional services.

Our focus on profitable revenue growth continues to be reflected in our cash position. We generated cash from operating activities of approximately $3 million and we ended the fourth quarter with $16.6 million in cash, up significantly from $15 million in the preceding quarter. We anticipate positive cash flow from operations next year.

In summary, we have been successful in the reduction of less essential costs and have remained focused on driving more profitable growth. We continue to invest in our on-demand infrastructure in support of demand.

The fourth quarter 2008 marked the third consecutive period in which the company achieve non-GAAP profitability and the third consecutive quarter with positive cash flow from operations. We reduced our debt obligations by over $4 million during the year and have minimal debt remaining on the balance sheet.

As Bobby discussed, we are making positive progress towards attaining our goals, generating earnings, and generating cash. We continue to see interest in our solutions; however, we also continue to be wary of the economy, even though it appears to not have materially affected those businesses and enterprises interested in purchasing our products thus far.

In addition, it’s still difficult to predict which customers will choose license or on-demand. This makes quarterly revenues more difficult to forecast. On a go-forward basis, therefore, we will share our expectations for financial performance for the full year.

Our guidance for 2009 is as follows: we are guiding total revenues of approximately $118 million, which represents growth of 10% over 2008 and in line with our analyst expectations, even in the face of that reported slowing economy. Total gross margins are expected to range from 60% to 62%, which includes the impact of amortization of acquired technology at $1.2 million and stock-based compensation of $400,000, and also includes the cost impact of investments in our on-demand infrastructure for anticipated expansion.

Operating expenses are expected to remain at the same level as the second half of 2008, or approximately 57% of revenue, and include amortization of purchased intangibles at $2.5 million and stock-based comp at $2.0 million. Depreciation expense is anticipated to total approximately $3 million in 2009.

For the full year, we anticipate approximately break-even earnings per share on a GAAP basis on a base of approximately 30 million shares. We expect to achieve non-GAAP earnings per diluted share of approximately $0.25 on the same base of approximately 30 million shares. We believe we will continue to generate cash and expect an increase in our overall cash balance at year-end, with total capital expenditures in the range of just under $4 million.

Let me now turn the call over to Bobby for his comments before we take your questions.

Bobby Yazdani

Thank you, Carol. Let me now update you on a number of key initiatives for fiscal year 2009. From a product perspective, we have four key initiatives that will drive our R&D priorities. The first is making collaboration more people-centric. Our Saba central platform is a unique asset in the human capital marketplace and we intend to increase the value of web conferencing to a focus on the people that participate in online sessions. While facilitating connections between people that participate in web conferences and virtual classes, we can now increase the productivity of remote teams and foster knowledge sharing across communities to increase organizational effectiveness.

We plan to unveil significant enhancements to Saba's central product line at our annual user conference, People 2008, which will be held in Washington, D.C. from October 20th to October 23rd.

The second is to increase the value of unified people management. As adoption of multiple solution across learning, performance, and talent management increases, we are seeing increased opportunity to differentiate our solutions while focusing on the unique benefits of the complete view of the development, performance, and career progressions of the workforce.

We are listening closely to our customers on how we can enhance the value they receive from our unified competency job and person profile across all our solutions.

Third is the global enterprise learning; as learning management evolves from point solution for certifications, channel training, or management development to an enterprise system that supports the entire global workforce, suppliers, and customers, Saba is well-positioned to expand use in existing accounts and win new enterprise deals. We will continue to enhance our learning offering to support the use across the extended enterprise. This includes focusing on the usability for users that may only access the system occasionally and adoptable interfaces to provide learning where and when diverse audiences require it.

Finally and importantly is to focus on streamlining the operational management and implementation of our on-demand solutions. We are leading with software as a service delivery for all our solutions and we will continue to improve our products to increase margins in our on-demand operations.

For the coming year, we intend to focus on cross-selling and up-selling our global customer base. We are doing this by deepening our customer relationships to regional user groups and online customer connection sessions, as with our upcoming annual user conference. For new business, we will focus on generating leads where the value of the unified people management, including employee development, is the central piece to the customer success. In addition, we will increasingly generate new types of business from initiatives to expand informal learning and collaboration, as organizations look to adopt web 2.0 practices to increase the effectiveness of their workforce.

Currently, about one-third of our sales come through indirect channel partners. We would like to increase this percentage coming from indirect channels to at least one-half over the next several years. We are actively pursuing a number of key distribution relationships in an effort to leverage indirect sales channels.

With that, I would like to turn the call over to you, Operator, for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from the line of Ryan Bergen with Craig-Hallum. Please go ahead.

Ryan Bergen - Craig-Hallum Capital

Thank you. Could you please talk more about the execution issues in the international business and specifically why those contracts were not able to close in Q4?

Bobby Yazdani

There were a couple of contracts that we just ran out of time and we ended up concluding them, believe it or not, the following week. We concluded one major contract, it was a fairly significant contract which was closed the following week after the quarter ended.

We also had a number of contracts that came in that, due to the nature of the contract, we have to recognize them in a ratable fashion and that was not what we forecasted. Earlier in the quarter, they were looking more like simple license contracts that at the time when the contract and the negotiations were concluded, we internally in our finance organization determined that we would like them -- we needed to take those contracts on a ratable basis over the next few years, so that’s what I meant by execution. Those type of things shouldn’t happen. We should have better visibility, both in terms of concluding negotiations or being able to forecast essentially the type of business that we are going to conclude with customers.

Ryan Bergen - Craig-Hallum Capital

What is the long-term revenue growth of the industry and each of the on-demand license and service segments?

Bobby Yazdani

You know, we are projecting essentially a 10% overall revenue growth. The on-demand growth, it’s going to be higher than the license growth. So what we’ve done, you know, our estimates and really also what we see bottoms up from the field that we are really seeing a significantly higher growth in the on-demand business than the license business going into the next year. We are seeing very good growth in our professional services business. We are seeing a modest, again reasonable growth in the maintenance and support, the same type of growth that we’ve seen over the past few quarters. All businesses look profitable. You know, we -- as you’ve seen, we have been able to -- we are going to be able to deliver the type of 10% growth that we have outlined with -- you know, essentially with the same cost of sales going into the next year, so the total cost and expenses should modestly increase while the top line is going to grow by 10%.

Ryan Bergen - Craig-Hallum Capital

Do you have specific growth targets for each of those segments and for the industry that you can provide to me?

Bobby Yazdani

We do. Of course, our internal growth plans is higher than what I’ve outlined here. As Carol indicated, our pipeline and the customer activities look healthy but the headline is always concerning us, you know, specifically North America, whether there will be a slowdown. So we are looking at the -- a modest 10% growth. We don’t believe that the market is essentially growing faster than our growth rate.

Ryan Bergen - Craig-Hallum Capital

Can you please comment on areas of investment, both hardware and people in your business? I know you’ve talked a lot about on-demand and the investment you are doing there, but just talk about the investment that you are doing in the business.

Bobby Yazdani

As I outlined, there are really three categories of initiatives. We have a set of R&D initiatives but we still will be able to execute those initiatives by capping essentially the R&D cost roughly around 14% to 15% of the total net revenue, so you are not going to see an increase essentially in the -- significant increase in the R&D expense. However, with that kind of an expense, we will be able to execute on sort of new initiatives, product initiatives, and all the things that we need to do to be a competitive supplier in our marketplace.

The bulk of two other sets of investments are concentrated around the on-demand, both in terms of the capital expenditure and people expense. I mean, we have -- are planning to grow the staff that manage our on-demand business. We are looking to grow that group essentially about 30%, 40% over the course of the -- you know, year over year, there would be that kind of a growth you will see in the on-demand, both in terms of staffing, in terms of the capital expenditure, there will be growth there.

And in the other area that we are investing, again we’ve capped [inaudible] marketing costs. We’d like to be below 30%. Within that cost structure, some of the key initiatives that we have introduced are focused around the channel development. You know, Olivia [Gazey], one of our senior folks has been promoted to take over that activity and is responsible for all the channels on a global basis and that’s a funded staff activity that we are going to be executing in 2009.

Ryan Bergen - Craig-Hallum Capital

Can you also update me on the progress of your CFO search?

Bobby Yazdani

I’m glad you asked the question. I anticipated that. We are right now and with the guidance by my board and you know, from my own belief, that we are today focused on closing our books and making sure that appropriately, we can go through this call and our filings are -- year-end filing. I mean, we have a competent staff, we have a competent leader -- Carol is leading this effort. We are very comfortable, my board, our head of audit committee, we are very confident that Carol will be able to take us through this process over the course of Q1.

We are of course -- we have a real internal candidate that we are working with and of course, myself and the board have and are currently talking to other candidates outside. We will make that decision by the end of the first quarter, once we get our filings and our work behind us.

Ryan Bergen - Craig-Hallum Capital

And one last question; can you please comment on what you are seeing for talent management trends in the international markets?

Bobby Yazdani

It’s a -- you know, last quarter when I look at the initiatives, Europe, we have actually have had a number of new contracts, new projects. It’s not I would say as mature as actually North America. North America still remains to be the most mature market in our mind. We are seeing very good activity in Asia-Pacific. We are also seeing activity and we have started servicing a number of clients in China now through our channel partners, so there are projects also started to show up in China.

Japan is a mixed bag; it’s not as broad of an adoption as we anticipated but all in all, I would say North America is the most mature. I would say there are pockets of markets in Asia that are very exciting and we are seeing new projects, and Europe, it’s the middle of the road. It’s not aggressively growing and it’s not dead either.

Ryan Bergen - Craig-Hallum Capital

Thank you.

Operator

Our next question is from the line of Michael Nemeroff with Wedbush.

Ariel Sokol - Wedbush Morgan Securities

This is Ariel Sokol for Michael Nemeroff. I just have a couple of questions for you; I guess starting off, I was hoping you could quantify the value of the slipped deals that were going to close in Q4 that ended up being closed in Q1?

Bobby Yazdani

It was in -- I can tell you it was in multiple millions of dollars.

Ariel Sokol - Wedbush Morgan Securities

Multiple millions -- would that be like two or four?

Bobby Yazdani

I would say it was around -- it was more than $1 million.

Ariel Sokol - Wedbush Morgan Securities

Okay.

Bobby Yazdani

Between $1 million to $2 million, let’s say.

Ariel Sokol - Wedbush Morgan Securities

Okay, and then as it relates to the strategic transaction cost, I was hoping you could speak a little bit to what kind of businesses are you looking to acquire, or alternatively what holes do you see in the product set that you need? Or was the business, was it an on-demand business or a subscription business?

Bobby Yazdani

Fair question -- of course, for strategic reasons, I don’t want to go into a lot of details. We don’t necessarily want to tip our hand of what we are trying to do. It was a very of course viable -- it was a very, in our mind, it was a very interesting and important transaction that the board, our board accommodate our request to look at that very closely and we proceeded. Unfortunately, as we outlined, we couldn’t conclude on that. However, we are from time to time, we are looking at transactions. I honestly believe that we have one of the best products suite in the market. We have a unified platform. We have spent a lot of money building the best product suite in the marketplace. Therefore, really there’s not a whole lot of product or functionality gaps that we see in our overall suite.

We would be interested to expand our footprint, either geographical footprint or channel footprint. We are interested in companies who, or partners who would potentially give us access to markets or a customer base that we don’t have access to.

Ariel Sokol - Wedbush Morgan Securities

Okay. Well then, next question then, in speaking about the guidance for fiscal year 2009, what percent of the revenue will be recurring in nature? And then what do you think the breakdown looks like in two years or even in five years? We’re just trying to understand the trajectory of the company.

Bobby Yazdani

Right. So you will see that if you look at our four lines of revenue, license, license update, on-demand, professional services, the most significant growth is going to come out of on-demand and professional services. The recurring revenue base would be probably around 50%, again 50% of $118 million, you can do the math, and it’s coming from maintenance and support and on-demand.

And as I outlined earlier, the biggest investment that’s impacting our -- really our gross margin is going to be the on-demand business.

Ariel Sokol - Wedbush Morgan Securities

Maybe I should ask the question a different way -- at what point do you think you can get your recurring revenue to constitute 60% or 65% of your total revenue? Is that something that you anticipate in the next two years, in the next three years, four years?

Bobby Yazdani

I would say that the run-rate exiting out of the next fiscal year would be closer to the numbers you mentioned.

Ariel Sokol - Wedbush Morgan Securities

Okay.

Bobby Yazdani

So around 60%.

Ariel Sokol - Wedbush Morgan Securities

So 60% by the end of Q4 of fiscal year 2010?

Bobby Yazdani

That’s 2009.

Ariel Sokol - Wedbush Morgan Securities

Oh, so 60% by Q4 of 2009 should be recurring?

Bobby Yazdani

Yes, that’s correct.

Ariel Sokol - Wedbush Morgan Securities

Okay, that’s very helpful. And then just moving on then to the competitive landscape, are you seeing any changes, you’re seeing the same people, do you still have the same win rates?

Bobby Yazdani

We do very well. Of course, our primary market, which is a learning management market, we continue to do very well there. We are winning complex, multi-nationals, typically north of 10,000 employees or learners. We do very well if there’s an initiative that is learning [inaudible], sort of like a talent management/human capital project that’s learning [inaudible] where the learning management is a key component of it.

We typically don’t participate in standalone performance management deals. That is not our sweet spot. We continuously focus to compete standalone, head-to-head when it’s a learning led project or a learning led project that’s going to expand towards the broader talent management suite, you know, performance management or talent management.

We are also doing quite well with our collaboration product, as Carol indicated. Forty-percent of the booking came from our collaboration product line. Don’t underestimate the good work that our people are putting in and we are winning. We have won a number of key projects in that market as well.

We are seeing now a trend with collaboration. It is also becoming a key component in an overall learning strategy or an informal learning strategy in that enterprise.

Ariel Sokol - Wedbush Morgan Securities

Okay, so if we could just focus on the cross-sell of Centra into the Saba installed base of customers and vice versa, what kind of rates are you are seeing? Of the deals that were signed for Centra and the deals that were signed for Saba LMS, what percent came from this cross-sell?

Bobby Yazdani

We are seeing -- actually, selling Centra into the LMS base is higher and selling LMS into the Centra base is lower, so we are seeing a much better adoption by the Saba customer of the Centra product line. They love the fact that it’s fully integrated to the LMS. There is a single installation, there is a single administration, there is single data management analytics now and all of those things are really enhancing essentially our position for learning customers as well as the learning opportunities.

Ariel Sokol - Wedbush Morgan Securities

Okay, so then as it relates then to the number of brand new customers signed in the quarter, how many were those, other than the cross-sell?

Bobby Yazdani

I don’t have the exact number but I can tell you that from the few deals that I recall, there were a number of new deals that were learning and Centra [inaudible], if that’s the question you’re asking. So we are seeing a fair good number of new deals that are -- both products are required by the customer.

Ariel Sokol - Wedbush Morgan Securities

Okay, and then one last easy question -- so what kind of tax rate are you guys expecting in fiscal year 2009? What should we be modeling?

Carol Rice-Murphy

Really good question. One of the things that we discussed in the press release has to do with the consumption of NOLs from two acquisitions and the accounting treatment around it, so we end up with a tax provision rate that seems somewhat unusual. I think that if you used probably 40%, something like that for your models, it would be representative. It’s going to depend a little bit on the quarter reflects, but in the aggregate 40%.

Ariel Sokol - Wedbush Morgan Securities

Okay, and then, just to be clear, is that for both pro forma and GAAP EPS, or is that just presumably for pro forma EPS?

Carol Rice-Murphy

Use that for GAAP.

Ariel Sokol - Wedbush Morgan Securities

Forty-percent for GAAP? And then what should we use for a pro forma earnings?

Carol Rice-Murphy

Yeah, okay, I would probably use -- and I don’t have that in front of me, this is just going to be an estimate right now -- somewhere in the neighborhood of maybe 5% or 10%, something like that.

Ariel Sokol - Wedbush Morgan Securities

Okay, great. Well, thanks for your time.

Operator

Our next question is from the line of Kevin Liu with B. Riley & Company. Please go ahead.

Kevin Liu - B. Riley & Company

Good afternoon. On the international side, it sounds like you kind of figured that a lot of the execution issues were primarily related to Q4. As you look out to the next quarter and maybe the first half of ’09, is there anything else out there that you feel needs to be fixed or do you pretty much have all the pieces in place at this point?

Bobby Yazdani

No, we’ve made some operational changes in the field and we put some new controls in place, not really the -- I’m getting, Kevin, more involved. I’m going to work with my international team over the course of the next 12 months much, much closer. We had previously a position where the field and the territories were removed essentially from -- you know, by an executive and we no longer have that, basically that tier of management, so Europe is directly reporting to myself and so is Asia-Pacific, and I would like to have that level of visibility to make sure that it’s performing as expected.

Kevin Liu - B. Riley & Company

And then just getting into the pipeline a little bit more, can you characterize where you see that 10% growth really coming from, both in terms of geographically, are you expecting any areas to be stronger than others? And then also in terms of on-demand versus your traditional licenses?

Bobby Yazdani

Okay, so let me give you the color bottoms-up where we see the contribution. First of all, over the past 12 months, we have been working with a number of channel partners, some very large ones that we believe that they are ramped. There are a number of good channel partners that were ramping in China, in India. They were also being ramped in certain territories in Europe that we didn’t have access to, including Russia.

So we believe that there would be a very good contribution from those channel partners, you know, over the -- you know, year over year they would be more productive in ’09 versus last year, so that’s one area that we are going to see contribution.

The other area that we are seeing is that the Asia-Pacific remains to be healthy. We are winning a number of very good contracts in Asia-Pacific, including India, and we are hoping that we will see a better contribution again in ’09 versus last year, so their growth is higher than the growth of the other territories in terms of the percentage of contribution.

We remain essentially skeptical in our planning around North America and we are also skeptical about Europe, and we are playing more defense in those territories and we are not going to expand our -- expand the [share] or footprint of coverage until we see it in our pipeline activity. So we are going to sit tight for the first half of the year to see how it is looking and then decide whether we want to invest for the second half of the year.

Canada in North America is promising. We have had a couple of really -- we had an announcement earlier in the quarter. We are seeing good traction in the state, local market. We’ve done very well there.

In terms of the on-demand, now Europe is instrumented with the on-demand offering and of course, the United States and Australia are all instrumented with the on-demand offering, all of our offerings are available in those territories on on-demand. The growth in the on-demand would be higher again than the license revenue year over year.

Kevin Liu - B. Riley & Company

All right, that’s helpful. Thank you. And then in terms of the on-demand gross margin, I mean, you’ve mentioned kind of the incremental expenses you are going to make in terms of the staffing side. Just curious where you see gross margins kind of exiting fiscal ’09, how much of an improvement can we expect from this quarter and any other sort of color you can give around that?

Bobby Yazdani

I think this quarter, I think the Q4 we’re sitting at 52%, so I mean, we made the bulk of the investment last quarter and this quarter. I mean, we just -- you know, we have increased the number of customers we have to service. I think the exit, Q4 exit, you know, you’re looking at it north of 60% so we would be expanding it from 52%. You know, it’s one of those areas that you have to make a big investment one-time and then as you grow the business, you will be able to realize the benefit of it.

So exiting Q4, it would be north of 60% from where it is today.

Kevin Liu - B. Riley & Company

Okay. And then lastly, I’m just wondering if you could provide the bookings number and the prior, just so we have the comparison?

Bobby Yazdani

It was essentially about a -- as I think -- you know, year over year -- if you look at the half of -- the best way to look at it I think is look at the second half of last year versus the second half of this year and you will see north of 10% growth.

Kevin Liu - B. Riley & Company

Okay. Thank you.

Operator

Our next question is from the line of Daniel [Still] with Z.F. Partners. Please go ahead.

Daniel Still - Z.F. Partners

I’m calling in on behalf of Steven. First, congrats on meeting several of your stated goals and particularly the generating operating cash flow. And kind of keeping with that theme, given that you’re generating operating cash flow and I believe it was mentioned earlier, you’re projecting to continue to generate cash flow, could you share some of your thoughts about usage of that cash? And maybe more specifically, any potential stock buy-backs?

Bobby Yazdani

Great question. I have -- let me back up. First of all, I’ve indicated that over the past 90 days, myself and my management team and our board, we were fully engaged looking at a strategic transaction, so that was a priority for us that we had to conclude. Going into the next year, right now my priority is to ensure that the company has a solid plan that our team can go and execute, and we are also completing our filings and appropriately concluding, you know, closing our books and ensuring that all of those things are behind us.

What you are suggesting is in the forefront of our mind. It makes sense. It’s something that the board has considered and is considering now. I am hoping that we will be able to conclude that and make a decision around what you are suggesting with our board in the near-term.

Daniel Still - Z.F. Partners

Terrific. Thank you.

Operator

Our next question is from the line of Charles [Frumberg] with [inaudible]. Please go ahead.

Charles Frumberg - Analyst

Just a couple of detail questions, a lot of mine were already asked, but just to sort of frame this correctly, can you just give a sense -- the organic growth of on-demand, can you both look backwards and give it a number? And also, the implication of 10% growth overall, with greater than 10% growth in on-demand, implies by its very nature that a good chunk of that, at least in the near-term, is visible or already in backlog or deferreds. Is that line of thinking correct?

Bobby Yazdani

That is correct. Essentially, we defensively, looking at the license growth year over year, and as I mentioned the growth that you -- enhanced because of the defensive license growth, you are going to see modest maintenance and support growth. The growth that we are anticipating that are double-digit, it’s going to come from on-demand and professional services.

Charles Frumberg - Analyst

Right, which has got to be quite visible at this stage.

Bobby Yazdani

That’s correct.

Charles Frumberg - Analyst

Okay.

Bobby Yazdani

Essentially, let me give you another place to look at -- take a look at the run-rate of the business and take a look at the run-rate cost of our business. We’ve done a lot of work over the past quarter and six months to ensure that the run-rate of the business is defensible and generating profit, and you can see where we are going with that. Take a look at the run-rate and that would give you essentially that level of visibility that we have into our ’09.

Charles Frumberg - Analyst

Okay. Can you -- just to bounce a little bit, professional services, can you give -- I’m sorry.

Bobby Yazdani

Go ahead.

Charles Frumberg - Analyst

Can you give a sense of the nature of the work and the trend in the margin? You know, is it value-added, is it implementation projects, is it generic? You know, just some sense of, since that’s where you are going to be achieving some above average growth as well.

Bobby Yazdani

Right, right. First of all, there is an attach rate of professional services to on-demand, so we can get a customer up and running in the on-demand service with minimal amount, but the customers are asking us to go back and help them expand the usage of the application. So the nature of the engagement initially is more of a technical and a project management, and then it goes into another phase where the nature of our engagement is more of a business consultant, a process expert.

Charles Frumberg - Analyst

Sure.

Bobby Yazdani

For instance, we have expertise in five key verticals today. I can have business consultants that can go into a financial services or they can go to a life sciences industry or they can go to a process manufacturer and help these clients in terms of the best practices of usage of our application in those areas. There are two other very interesting verticals we are building expertise. One is retail, the other one is public sector.

Charles Frumberg - Analyst

And the trend in your billing rates?

Bobby Yazdani

As you see that, it’s a very healthy, profitable business. I think the margin was north of 30%. The billing rate has stayed quite constant. We are not seeing a deterioration. It’s in the $180, $190 an hour kind of a rate. That’s a blended rate, of course, that I’m giving you.

Charles Frumberg - Analyst

Sure, sure. At the risk of beating a dead horse on the buy-back here, first of all, congratulations on cash flow generation. You know, you’ve certainly -- from at least our discussions and I think your public pronouncements about that being a goal, you have very good free cash flow generation, and I’d suggest down here whether -- and I know it sounds like scale is important towards your long-term business strategy, so to the extent that you have a fair amount of free cash flow, I’d suggest that, particularly with the stock down here, it is a -- by almost -- the math of it is accretive. And without taxing your balance sheet, it would seem -- we’re not normally big buy-back proponents here, but using your excess cash flow generation sort of like -- Actuate does this. You know, they sort of go to market and eat up that excess supply of stock. It shrinks your share base and frankly, the benefits of your execution accrete to those that stay. So whether you are thinking of something bigger, at a minimum that would be sort of the type of plan that would be I think well-received, certainly from this county. And so with the effect it ultimately is beneficial to your shares, that’s good for you whether you are a buyer of companies or a seller of yours over time.

Bobby Yazdani

You’re right. We have had this suggestion been made to us by a number of our shareholders. Our board, myself, we want to see a continuation of our [inaudible] strategy, grow profitably, generate cash. Now this is three quarters that we want, as I said, to come back to -- I mean, this is something that our board and myself are well aware of it. The past 90 days, we’ve had a number of priorities ahead of us that we had to resolve and get behind us, which we have. Now we are going to proceed along these lines and your suggestion and a number of other shareholders suggestions is right on. It’s something that absolutely we need to consider and I assure you, that’s been there for part of our thinking. We’re on the same page.

Charles Frumberg - Analyst

Great. I’m done. Thank you.

Operator

(Operator Instructions) We do have a question in queue from James [Bocsh] with Dialectic Capital. Please go ahead.

James Bocsh - Dialectic Capital

It’s nice to hear from other shareholders almost a uniform opinion to be looking at a buy-back if you are going to be generating excess cash flow, especially at this valuation versus other alternatives. Certainly we fall into that camp as well.

To the extent that you do look at alternatives, again which we wouldn’t want you to do in terms of looking at other acquisitions, thinking that your highest return of invested capital is going to be your own stock, to the extent that you do look at all other alternatives, such as acquiring companies, can you give us a sense of the size? So maximum size that you would potentially be looking at and pursing in acquisition?

Bobby Yazdani

If you look at our discipline around acquisitions over the past few years, I mean, we are no different than many of you guys -- we are value buyers. We are very disciplined around -- you know, look at our share count. I mean, our share counts haven’t really materially moved over the past two years. I’m very sensitive -- my team and my board is quite sensitive towards your ownership and our investors ownership, not to dilute our current investors. So we are very sensitive. I can assure you we are quite sensitive towards that.

In terms of the nature of these transactions, as I said earlier on, this is not about a product or a technology gap. You know, we have the best product suite in the marketplace. We’ve made a significant amount of R&D dollars in our products. Our products are being deployed in some of the biggest companies in the world, most sophisticated companies in the world -- IBM, HP, Cisco, you know, Banc of America and the list goes on. We’ve done very well getting our technology adopted with very complex companies and partners.

So I believe that we need to look at opportunities where we change the landscape in terms of the leadership of the company and essentially creating value for our shareholders. It has to be highly accretive. It has to be highly strategic and it has to move the needle. If it does not move the needle and -- you know, we are very risk averse. We believe there is a lot more risk in doing things. I’m more of the mindset of staying the course, grow profitably, generate cash, and I would apologize for the performance of the stock but that’s the best we can do for our shareholders to stay very disciplined around generating cash and staying profitable.

James Bocsh - Dialectic Capital

I completely understand. I guess in the context though of where the stock is and where your cash balance is, I’m going to assume -- and I’d like you to confirm -- that you are not going to do any type of equity raise if you are going to purse an acquisition at this point. And I guess as another corollary to that, what is the cash level that you don’t want to go below? Or is there feedback from your customers, since you have a high degree of recurring maintenance and professional services revenues? What’s the cash flow level your customers don’t want you to go below? So I guess two parts -- one, confirmation there’s not going to be any raise, which would obviously be probably not a favorable decision at these levels, stock price levels; and second, a cash flow level.

Bobby Yazdani

Just to use that, the questions you are asking of course needs to be directed by our board, and I’m a member of that team and I am one voice. I am of the opinion that at these levels, I would like to see us very disciplined around generating cash and staying profitable. And I don’t believe that it’s necessary for us to doing anything to change the landscape in terms of the -- you know, any activity that would be dilutive to our shareholders.

Now, I am -- as I said, this is not my decision; it’s my board’s decision. If the board considers a transaction where it would be significant value to our shareholders, and I can assure you they would evaluate this very diligently, you know, I would follow my board’s command. So that’s my opinion.

Again, the other question you asked is that -- look, we are on the same page. As I said, I take full responsibility for the results of the company. The things that we can control, this management team can control, is the discipline around generating cash and being profitable, and in this environment, that’s our strategy. It’s not really chasing the top line growth. We want to be very disciplined about that. We want to be very disciplined around the sales and marketing cost.

James Bocsh - Dialectic Capital

Great. Good to hear. Good luck going forward.

Operator

Thank you. There are no other questions in queue.

Bobby Yazdani

Great. Well, thank you very much for joining us this afternoon.

Carol Rice-Murphy

Yes, thank you.

Operator

Thank you. Ladies and gentlemen, that does conclude your conference for today. Thanks for your participation and you may now disconnect.

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