JDA Software Group (JDAS) Q1 2011 Earnings Call April 26, 2011 4:45 pm ET

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the JDA Software Group Inc. First Quarter 2011 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Tuesday, April 26, 2011. I would now like to turn the conference over to our host, Mr. Mike Burnett, Vice President of Investor Relations. Please go ahead, sir.

Mike Burnett

Thank you, Camille. Good afternoon, and welcome to the JDA Software earnings call for the first quarter ending March 31, 2011.

We have begun 2011 with a solid performance led by broad-based strength in each line of business and across the geographic regions in which we operate. Record first quarter revenues drove strong earnings and cash flow to kick off the year.

On our call today, we will discuss the operational and financial results for the first quarter. With me on the call is Hamish Brewer, Chief Executive Officer of JDA Software; and Peter Hathaway, our Chief Financial Officer.

Before we begin discussing our results, let me remind you that our comments today will contain certain forward-looking statements that often involve risks, uncertainties and assumptions. All statements other than statements of historical facts are statements that could be deemed to be forward-looking. These risks are described from time to time in our SEC reports including, but not limited to, our annual report on Form 10-K for the year ended December 31, 2010.

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

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

Hamish Brewer

Thank you, Mike. As many of you may remember, in January this year, we laid out an ambitious plan to accelerate the pace of organic growth of the company driven by sales. I’m very pleased to be able to report that although there still remains much to be done this year, after the first quarter, I believe we’re on track to achieve our annual goals.

We generated record first quarter revenues in all our major revenue lines, and we did this coming off the back of the biggest fourth quarter in the history of the company. Today, I’d like to take you through the major lines of business and provide some more color on our achievements, but before I do that, I’d like to highlight some of the most objective reasons why I believe we are succeeding.

Focusing on innovation and competitiveness, there’s little doubt in my mind that the recent recession has brought the need for superior supply chain execution firmly into focus for most companies in our target market. When you combine the recent downturn with increasing volatility in commodities markets, supply capacity disconnects and, of course, unexpected disruptions like the recent tragedy in Japan, what you see is a confluence of factors, all of which lead companies to focus on better planning, superior agility and optimized decision-making across global supply networks. This kind of business performance is almost impossible to achieve without advanced planning and optimization tools. While many companies have tried to achieve these capabilities with their traditional ERP systems, the evidence suggests overwhelmingly that specialized suites of solutions consistently outperformed the more generic functionality provided by ERP.

Today, JDA owns the broadest suite of specialized merchandising, pricing and supply chain solutions available anywhere, providing a unique combination of broad suite capabilities along with in-depth specialized optimization. So as we integrate the JDA and i2 suites of products together into 1 seamless offering, a process which will be substantially complete by the end of 2012, this integration will yield transformational capabilities for manufacturers, distributors and retailers everywhere.

Combined with the advantages of this broad suite, our focus on in-depth innovation in each functional domain provides a unique and compelling offering. The depth of our ongoing innovation is reflected in our patent portfolio, where we hold an unmatched 240 patents in this domain, and we have another 102 U.S. patents in process.

So while the results of the first quarter are impressive and satisfying in themselves, I’d also like you to know that I feel very optimistic about our market positioning, competitiveness and the benefits that we have yet to unlock as we complete the delivery of our 3-year roadmap, which is still only 1/3 complete but on track to deliver over the next 2 years. For example, this year alone, we will deliver major new capabilities in the areas of sales and operations planning, inventory optimization and assortment management. So our first quarter financial results are excellent, but they’re also built on something which is fundamental and durable in our business.

Moving on to consider those recent results. Starting in sales, first quarter license sales were not only a record but 27% up year-over-year basis, clearly an excellent result and a great start towards our annual objective of $145 million to $160 million of license and subscription sales.

Americas delivered a solid performance with a 12% increase over last year, but the star performance was from Europe, where we delivered 133% increase over last year. As I said on the January call, we are still in rebuild mode in Europe, so I expect results to be lumpy for some time, but this performance clearly indicates that we’re headed in the right direction.

Asia-Pacific performance were lackluster, and frankly, we may continue to see softness in this region until things settle down in Japan, which is our biggest market in Asia. So our plan to invest in sales to increase our rate of organic growth is off to a good start, but we still have plenty more to do in 2011.

As you have seen today, we decided to place Tom Dziersk as our new worldwide Executive Vice President of Sales and Marketing, a move which also comes with a plan to increase the global integration of our sales organization in order to increase effectiveness worldwide. We believe that if we can better leverage our U.S. organization and resources internationally, then potentially, we can achieve greater sales effectiveness around the world.

Services revenues in the first quarter was strong with a 36% year-over-year increase, but we continue to struggle with margins. As I mentioned in January, we have a 3-year plan to improve margins, but to remind everyone, I do not expect to make significant progress towards our gross margin objective of mid- to high 20s this year, and I expect the current low margins to continue through Q2.

Qualitatively, I can tell you that we made significant progress integrating the JDA and i2 consulting businesses, and our overall quality of customer delivery is consistently improving. Related to this metric of customer satisfaction, I’m very pleased to be able to report that maintenance retention continues to perform very well. In the first quarter, we saw maintenance retention rates of 98.5% compared to 98.3% in the first quarter of last year. Remember that the maintenance retention rate is a year-to-date statistics, so attrition will continue to climb cumulatively through the year. And as a data point, our retention rate for all of 2010 was 96% — 95.6%. Nonetheless, this first quarter result is better than last year and is a remarkable achievement and clearly indicates our customers’ commitment to JDA solutions, which, in turn, drives earnings and cash flow.

The first quarter is our biggest renewals quarter of the year. And also, we have now anniversary-ed all of the i2 maintenance contract renewals. Our managed services business continues to make progress, closing 25 net new deals in the first quarter. Revenues in this area are running a little bit behind plan as a result of the late closure of a few contracts, but we’re still optimistic that we can make good progress this year. Combined, these results generated record total revenues of $163.6 million, representing 24% of the midpoint of our annual outlook. This revenue generated $37.8 million of adjusted EBITDA, which is 21% of the midpoint of our annual EBITDA target. The lower EBITDA contribution was caused primarily by some nonrecurring expenses and higher mix of consulting revenue at lower margins.

Finally, with cash sitting at $260 million at the end of the quarter, we had a very strong cash collection performance, and our DSOs remained excellent. So overall, I’m very satisfied with these results, providing an excellent start to the growth targets we set ourselves for 2011.

At the end of this week, we headed — we head off to Orlando for our annual user conference. We have registered attendance currently sitting at 1,659. We expect to have an excellent opportunity to spend a few days discussing where our customers are going, what they need from us and how we can work together to continue down the path of business process optimization, driving real results to their balance sheets and P&Ls.

And so with that, I’d like to hand it over to Pete to provide an in-depth review of the financial results.

Peter Hathaway

Thanks, Hamish. We are pleased with the strong results generated in the first quarter. We believe this solid start to the year provides us with continued confidence in our operational and financial goals for 2011.

Before I discuss the results for the quarter, I would like to note that the first quarter numbers for 2010 contain the results for the i2 acquisition for only 2 of the 3 months in the quarter due to the acquisition occurring on January 28, 2010. This is relevant because the first month of the quarter is negatively impacted by the back-end loading of software sales, while the majority of our cost structure is fixed and ratable throughout the quarter.

On a pro forma basis, the impact of the January 2010 results for i2 on our Q1 2010 reported results would result in greater year-over-year margin expansion. After this quarter, we will be comparing apples to apples. I’ll point out the pro forma effects as I go through my comments.

For the first quarter 2011, adjusted EBITDA increased 20% to $37.8 million from $31.4 million in Q1 2010. Adjusted EBITDA includes $3.8 million in litigation costs compared to just under $1 million in Q1 of the prior year. The adjusted EBITDA margin of 23.1% was down slightly from 23.7% in Q1 of 2010 partly because of the revenue mix change and partly because of nonrecurring legal and severance costs. In addition, if I make the pro forma adjustment to Q1 2010 for the additional month of i2 last year, EBITDA would have increased by 130 basis points year-over-year.

Adjusted earnings per share increased 18% to $0.45 from $0.38 in the first quarter 2010 primarily due to the profitable growth from the acquisition of i2 and the achievement of the cost savings associated with the acquisition.

Adjusted EBITDA and adjusted EPS figures exclude the conventional items related to amortization, stock-based compensation and acquisition transition and restructuring charges, all of which are separately identified in the tearsheet attached to the press release.

In addition, the current year period excludes $37.5 million patent infringement lawsuit settlement income from Oracle. GAAP earnings per share increased to $1.07 from a loss per share of $0.11 in Q1 of the prior year.

Total revenues increased 24% to $163.6 million for the quarter, including a first quarter record $36.5 million of software and subscription revenues as compared to total revenues of $131.6 million in software and subscription revenues of $28.7 million for the first quarter 2010. We closed 48 new software deals in the quarter compared to 52 in the first quarter of 2010, including 6 large transactions of $1 million or more in Q1 2011 compared to 8 in Q1 of last year.

Our average selling price for the trailing 12 months ended December 31, 2010, increased to — excuse me, ended March 31, 2011, increased to $720,000 from $601,000 in the fourth quarter and $618,000 last year.

1 item to point out for software subscription revenue is that some of the i2 subscription customers have come up for renewal. We have been converting them to perpetual license customers with maintenance attached. As a result, we still get recurring revenue from maintenance while our software subscription revenue line declined as it did in both Q4 and Q1. We expect this line to run at a quarterly rate of approximately $3.5 million for the remainder of the year.

Maintenance revenue presented another solid quarter. Our customer retention rate on expiring maintenance contracts is holding up as one of the highest in the industry. We ended the quarter with a year-to-date retention rate of 98.5%. This is a fantastic result and even compares favorably to Q1 of last year at 98.3%.

Maintenance revenues increased 14% to $64.8 million in Q1 2011 compared to $57 million in the first quarter of 2010. And the maintenance gross margin was 78.4% compared to 78.9% in the prior year. This recurring high-margin revenue and cash flow stream represented almost 40% of our revenue in the quarter.

Services revenue increased 36% to $62.4 million from $45.8 million in Q1 2010, while our gross margin increased to 17.7% from 16.9% in Q1 of 2010. The utilization rate increased to 56% for Q1 2011 from 53% in Q4 2010 but decreased from 59% in Q1 2010. We are pleased with the robust revenue growth in this area.

Moving on to operating costs. We continue to see positive leverage in the operating cost structure. Total operating expense as a percentage of revenue improved to 41.8% in the quarter compared to 42.6% in Q1 of 2010. This excludes the amortization of intangibles, restructuring and acquisition-related charges, as well as the Oracle litigation settlement income. Making the pro forma adjustment to Q1 2010 for the additional month of i2 last year, operating margin would have increased by 240 basis points year-over-year.

Product development expenses this quarter increased to $20.1 million from $17.3 million in Q1 2010, primarily due to the addition of the costs associated with i2. However, as a percentage of total revenue, product development cost declined 80 basis points to 12.3% from 13.1% in the prior year’s first quarter.

Sales and marketing expenses also increased this quarter to $26.2 million from $21.1 million in Q1 2010 due to the addition of i2. Commission expense for Q1 this year is up about $1.2 million following the strong increase in software sales. As a percentage of total revenue, these costs were comparable to Q1 2010 at 16%.

As we discussed on the Q — on the 2011 outlook call in January, we are investing in sales and marketing this year, given the opportunities we see in our markets. Accordingly, we expect sales and marketing expenses to approximate $29 million per quarter as a result of the increased hiring and merit adjustments.

Similarly, general and administrative expenses increased to $22.1 million from $17.7 million in Q1 2010. As a percentage of total revenue, these costs increased slightly to 13.5% from 13.4% in Q1 2010. Excluding the severance charge of $2 million in the quarter, G&A expenses as a percentage of revenue would have been 12.3%. We also incurred $3.8 million of legal expenses in the current quarter associated with litigation matters including the patent infringement case against Oracle and the Dillard’s matter. Litigation costs last year were about $1 million. Our outlook for 2011 originally included approximately $10 million of costs related to legal matters in 2011. Now, after the favorable resolution of the Oracle patent infringement suit, we expect to save at least $2 million for the year. As a reminder, annual merit increases of approximately 3.5% for all associates took effect on April 1.

The effective tax rate on GAAP earnings was 7.7% for the quarter. This differed from the adjusted effective tax rate of 35% primarily because the proceeds from the Oracle settlement are not taxable, resulting in a permanent income tax benefit.

Turning now to cash flow. We generated $59 million of operating cash flow in Q1 2011. Operating cash flow in the current period was primarily driven by the $35 million received from Oracle and strong earnings in the quarter, partly offset by a use of working capital, which is primarily due to the increase in receivables from the seasonally high maintenance billings. DSO in the first quarter of 2011 was 76 days compared to 74 days in Q1 2010. We usually have our highest DSO in the first quarter each year because we have more maintenance renewals to be collected at the beginning of the year than in any other quarter. Free cash flow was $56 million after spending $3 million on capital expenditures during the quarter compared to $500,000 in the first quarter of 2010. Consistent with our outlook for 2011 capital spending of between $25 million and $30 million, we expect to average about $8 million of CapEx per quarter for the remainder of the year. Our cash position at quarter-end increased to $260.5 million, including restricted cash of $34 million, leaving a net debt position of approximately $12 million.

Additionally, in March, we put in place a credit facility that provides a $100 million line of credit at a current interest rate of approximately 2.5%. We do not have any amounts drawn under the facility, but it provides the company with a very attractively priced liquidity.

In summary, we look at the first quarter as a good start to the year and in line with our full year expectations. We continue to generate positive momentum in the market that, through hard work and execution, should keep us positioned to meet our goals and expand our position as The Supply Chain Company.

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