Manhattan Associates, Inc. (MANH) Q1 2011 Earnings Report, Transcript and Summary

Good afternoon. My name is Jessica, and I will be our conference facilitator today. At this time, I'd like to welcome everyone to the Manhattan Associates First Quarter 2011 Earnings Conference Call. [Operator Instructions] I would now like to introduce Dennis Story of Manhattan Associates. Mr. Story, you may begin your conference.

Thank you, Jessica, and good afternoon, everyone. Welcome to Manhattan Associates 2011 First Quarter Earnings Call. I will review our cautionary language and then turn the call over to Pete Sinisgalli, our CEO. During this call, including the question-and-answer session, we may make forward-looking statements regarding future events or future financial performance of Manhattan Associates. You are cautioned that these forward-looking statements involve risk and uncertainties, are not guarantees of future performance and that actual results may differ materially from those in our forward-looking statements. I refer you to the reports Manhattan Associates files with the SEC for important factors that could cause actual results to differ materially from those in our projections, particularly our annual report on Form 10-K for fiscal 2010 and the risk factor discussion in that report. We are under no obligation to update these statements. In addition, our comments will cover certain non-GAAP financial measures. These measures are not in accordance with or an alternative for GAAP and may be different from non-GAAP measures used by other companies. We believe that this presentation of certain non-GAAP measures facilitates investors’ understanding of our historical operating trends with useful insight into our profitability, exclusive of unusual adjustments. Our Form 8-K filed today with the SEC and available from our website, manh.com, contains important disclosure about our use of non-GAAP measures. In addition, our earnings release filed with the Form 8-K reconciles our non-GAAP measures to the most directly comparable GAAP measures. Now I'll turn the call over to Pete.

Thanks, Dennis. I'll start the call with an overview of our performance in the first quarter. Dennis will follow with details about our financial results, and I'll return to cover operating activities for the quarter. And then, we'll be happy to answer your questions. Adjusted earnings per share for the first quarter was $0.41. That's up $0.01 from last year. I'm pleased with our financial results in all areas but one, license revenue. We posted disappointing license revenue of $7.8 million in the quarter. That miss was offset by solid revenue growth in services, expense management and an India tax adjustment. Our competitive win rate in the quarter was very strong at almost 80%. However, similar to last quarter, not enough large deals closed this quarter. We had only one large deal with recognized revenue greater than $1 million in the quarter. Unfortunately, the same lack of urgency that delayed large deal closings in Q4 of last year is still a factor. We continue to have a very healthy pipeline of large deals and high confidence that Manhattan will be selected when those deals do close. I'll provide more color about this following Dennis' review of our financial results. Dennis?

Thanks, Pete. As you know, our Q1 earnings were constrained by lower license revenue while at the same time underpinned by services revenue growth, strong services margins, expense control and a timely tax benefit. Pete will provide more perspective on our license revenue result and outlook in his comments. But before I jump into the results, let me remind you, we are now reporting adjusted results, excluding restricted stock, and our prior year results have been updated accordingly to reflect this change. Our supplemental schedules included in today's earnings release provide all of the details. So here's our financial summary for the first quarter. First, Q1 license revenue of $7.8 million decreased from $14.2 million in Q1 2010 and declined sequentially from $12.7 million in Q4 2010. Secondly, Q1 services revenue increased 5% year-over-year as demand continues to be strong. This 5% growth rate is artificially low due to previously deferred services revenue included in the Q1 2010 results. Apples-to-apples, our consulting revenue is up 11% year-over-year. And in addition, our services backlog is quite healthy. 3, margins are strong. In a tough license quarter, we achieved a gross margin of 55.2%, delivering services margins of 56.1% and a solid operating margin of 14.5%. We remain committed to achieving our year-over-year operating margin expansion objectives. 4, adjusted earnings per share of $0.41 increased 3% over the $0.40 we reported in Q1 2010. And on a GAAP basis, we delivered earnings per share of $0.32 even with the $0.32 delivered in the prior year. 5, our Q1 adjusted effective tax rate was 14.1% against our plan of 34.5% due primarily to a change in the tax laws in India, resulting in a tax benefit of approximately $2 million or $0.09 of EPS benefit in the quarter. 6, operating cash flow remained strong at $8.1 million for the quarter. And finally, 7, our balance sheet strength continues. Cash and investments totaled $119 million. Our cash-to-asset ratio is 44%, and we continue to carry no debt. We invested $26 million in common stock buybacks during Q1, and our board raised our buyback authority to a total of $50 million this month, April 2011. That covers the key summary points. Now for the details. Q1 total revenue performance of $71.7 million declined 3% year-over-year due to the lower than planned large license deals in the quarter. Our Americas segment reported total revenue of $60.2 million in the quarter, a year-over-year decline of 3%, resulting from a drop in license revenue. Internationally, although both geos experienced a year-over-year decline in license revenue, EMEA's Q1 2011 total revenue of $8.3 million increased by 4% over Q1 2010, driven by strong services revenue performance, while APAC posted $3.2 million in total revenue, down 22% from 2010 due to low license sales. For license revenue, in the quarter, Americas recognized $6.8 million, down from $11.1 million in Q1 2010. Activity in the small to mid-sized deals, which are in the $250,000 to $999,000 range, continue to remain solid, while the current sales cycle for deals greater than $1 million has extended somewhat in recent quarters. EMEA's Q1 license revenue totaled $449,000, posting another weak quarter as the Western European economy continues to experience a sluggish recovery. And finally, our APAC team delivered Q1 license revenue totaling $464,000. Services revenue of $56.1 million in the quarter increased 5% compared to Q1 2010 and was up 8% sequentially from Q4 2010 due to the Q4 seasonal holiday period. Our consulting services continued to experience solid demand with revenues of $35.2 million, increasing 4% over Q1 2010. However, when you consider that our Q1 2010 consulting revenue recognized nearly $2 million of previously deferred consulting revenue or $0.05 of EPS benefit on an apples-to-apples basis, we actually delivered double-digit year-over-year growth of 11%. First quarter maintenance revenue of $20.9 million reflects growth of 7% over Q1 2010 due to continued strong customer retention rates of 90-plus percent and solid cash collections in the quarter. Driven by strong demand, we expect Q2 2011 total services revenue to increase about 9% to 11% sequentially over Q1 2011. Consolidated services margins continue to be strong as we posted 56.1% in the quarter, up from 55.6% in Q1 2010 due to solid demand and up sequentially from 52.3% in Q4 2010 as fourth quarter services margins are historically lower due to Q4 seasonal holidays. With solid services demand, we are now estimating our full year 2011 services margins to be in the 54% to 55% range, an increase of 100 basis points over our previous expectation. Seasonal vacations in the Q4 holiday season caused the full year expected services margins to be lower than the margin we achieved in Q1 2011. Moving on to adjusted operating income. Q1 adjusted operating income totaled $10.4 million with a solid operating margin of 14.5%. This compares to a 19.3% operating margin in Q1 2010, which was favorably impacted by the nearly $2 million of previously deferred consulting revenue from 2009 and higher license revenue. As mentioned in our February call, starting this quarter, we began reporting adjusted earnings in accordance with the prevalent practice in the technology sector, excluding 100% of all equity-based compensation expense. Excluding restricted stock from our adjusted earnings resulted in a 2010 full year adjusted operating margin of 18%, which is the more accurate comparison against our software peers. At this time, we are still expecting a 100 basis point improvement over 2010's adjusted operating margin. Obviously, license revenue performance for the balance of the year is essential to achieving our full year objective. Moving on to operating expenses. In line with our expectations discussed in the Q4 2010 call, adjusted operating expenses, which include sales and marketing, R&D, G&A and depreciation, were $29.2 million for Q1 2011, an increase of 5% sequentially from Q4 2010 and essentially flat compared to the $29.3 million spent in Q1 2010. The sequential increase from Q4 2010 was due to annual merit and promotional increases for existing staff effective January 1, seasonally high FICA expenses, a partial reinstatement of our 401(k) match program and moderate headcount additions, partially offset by lower performance-based compensation in the quarter. Regarding income taxes. Our adjusted effective income tax rate for Q1 2011 was 14.1% against a plan of 34.5%. This was driven by a change in India tax law late in Q1 2011, eliminating the tax holiday for companies under the STPI, that stands for Software Technology Park of India, tax plan. The STPI tax plan is analogous to a special enterprise zone established to incent foreign direct investment. This change became effective April 1, 2011, which in turn triggered a $2 million tax benefit from the release of a valuation allowance associated with prepaid India income taxes. Just a little background on this. We established operations in Bangalore in 2002 under the STPI tax plan, which was designed as a 10-year tax holiday set to expire in 2012. However, over the past several years, the tax environment in India has become very aggressive. In 2007, India introduced a prepaid minimum alternative tax requirement for STPI participants to generate additional cash tax revenue, which could be carried forward and credited against future income tax liability after the expiration of the STPI tax holiday. Due to uncertainty about our ability to benefit from this tax carryforward, under U.S. GAAP, Generally Accepted Accounting Principles, we were required to establish a valuation allowance against the prepaid asset and recognized income tax expense, which has averaged about $500,000 per annum since 2007. This expense has been included in both our adjusted and GAAP earnings each year and has been a component of our effective tax rate management. We will utilize the $2 million tax carryforward starting in 2011 to offset a portion of the annual statutory income tax liability. And we currently project about a 4-year carryforward cash benefit under current Indian tax laws. This is factored into our revised effective tax rate estimate. Additionally, the U.S. Congress has already approved the extension of the R&D tax credit through 2011. Therefore, barring any further tax legislation or unexpected tax related issues, we expect our effective tax rate for the remaining 3 quarters of 2011 to be 33.5%, down from our previous estimate of 34.5% for both adjusted and GAAP results. Transitioning to diluted shares. For the quarter, diluted shares totaled 22.1 million shares, down from 22.4 million shares in Q4 2010. The decrease was driven by share repurchase activity in the quarter, partially offset by option exercises and the impact of a rising stock price on our common stock equivalents calculation. During the quarter, we repurchased 826,000 shares of Manhattan common stock at an average share price of $31.01, totaling $25.6 million. Option exercises in the quarter totaled 485,000 shares, generating net cash proceeds of $11.5 million. With significant stock price appreciation since 2009, 2.1 million options have been exercised over the past 5 quarters. In this period, options outstanding have declined 43%, substantially reducing the company's equity overhang position. Also during this same period, our share buybacks have totaled 3.5 million shares, mitigating any dilutive impact of option exercises while generating positive earnings accretion to our shareholders. As mentioned earlier, in April 2011, our board approved raising our remaining share repurchase authority limit to a total of $50 million. And for the remainder of 2011, we are estimating full year in quarterly diluted shares to total about 22.5 million shares. Our estimates do not assume any common stock repurchases and depend on a number of variables such as stock price, option exercises, forfeitures and share repurchases, which can significantly impact our estimates. On a GAAP basis, Q1 2011 GAAP diluted earnings per share of $0.32 was flat with the $0.32 we earned in Q1 2010. A detailed description of GAAP to non-GAAP adjustments can be found in the supplemental schedule, reconciling selected GAAP to non-GAAP measures in our earnings release today. Moving on to cash flow and balance sheet metrics. For the quarter, we delivered cash flow from operations of $8.1 million, down from $13.9 million in 2010. This is primarily driven by the cash payout of higher 2010 annual bonuses in Q1 2011 versus 2009 annual bonus payouts in Q1 of 2010. If you recall, 2009 bonus payouts in Q1 2010 were substantially lower, reflecting our relative business performance. Our accounts receivable balance has decreased $2 million from December of 2010 on strong operating margins in the quarter. Our DSOs continue to be solid at 57 days compared to Q4 2010 DSO of 61 days. Capital expenditures were $1.3 million in the quarter. And for 2011, we continue to estimate capital expenditures to be about $6 million to $8 million. Our cash and investments at March 31, 2011, totaled $119 million compared to December 31, 2010, cash of $127 million. The decline was driven by our investment and share buybacks. Deferred revenue, which primarily consist of maintenance revenue billed in advance of performing the maintenance services, was $52 million at March 31, 2011, compared to $45 million at December 31, 2010. Additionally, we have collected and deferred about $4 million of services revenue associated with customer commitments to provide certain product functionality. We anticipate that the commitments will be fulfilled and revenue will be recognized in 2011 beginning in Q2. That covers my Q1 remarks. So let me review our updated guidance, and then I'll turn the call back to Pete. For 2011 revenue, despite our Q1 license revenue performance, we are maintaining our annual total revenue guidance range of $325 million to $330 million, which represents 10% to 11% growth over 2010. For the balance of the 2011 year, we are forecasting quarterly revenue to be at about equal on a quarter-to-quarter basis, adjusting for slightly higher Q2 revenue reflecting expected recognition of some deferred services revenue, slightly lower Q3 license revenue and Q4 traditional services revenue decline driven by seasonal holidays. For 2011 adjusted earnings per share. Similar to our view of 2011 revenue, we are maintaining our 2011 view of operating results and adding to that the benefits of the India tax adjustment and a lower forecast tax rate. The India tax benefit we received in Q1 2011 generated about $0.09 in earnings per share, and we expect the decrease in the underlying effective tax rate from 34.5% to 33.5% to generate about $0.02 of additional incremental earnings per share. As a result, we are raising our previous full year guidance from a range of $1.77 to $1.82 by $0.10 to a new range of $1.87 to $1.92. This new range now represents 18% to 21% growth over 2010 adjusted diluted EPS of $1.58. We expect quarterly earnings per share for the remainder of the year to be roughly equal, with the exception of Q4, which typically is down slightly due to seasonal holidays. For 2011 GAAP earnings per share. Consistent with the increase in adjusted earnings per share, we now expect to deliver GAAP EPS of $1.55 to $1.60, representing 24% to 28% growth over 2010 GAAP diluted EPS of $1.25. The $0.32 full year EPS difference between GAAP and non-GAAP adjusted EPS represents equity-based compensation plus restricted stock and intangible asset amortization from acquisitions. The per quarter EPS impact to these items is estimated evenly at about $0.08 per quarter. Regarding adjusted operating margins. As I've stated earlier, we continue to focus on year-over-year operating margin expansion and are targeting a 100 basis point improvement over 2010. That covers the 2011 guidance. Now I'll turn the call back to Pete for the business update.

Thanks, Dennis. Q1 was a frustrating quarter for recognized license revenue. Our selling teams around the world and, in particular, the U.S. are very busy. The activity level is encouraging but the close rates frustrating. Because all software is often just a part of much larger capital commitments to facilities and material handling equipment, lingering uncertainty in the global macro environment affects our close rate, particularly for $1 million-plus deals. Some prospects continue to suffer through using existing solutions, waiting for the right time to invest. With each passing quarter, these legacy system age and pent up demand grows. For Q1 2011, the one large deal closed in the quarter was with an existing customer for our Warehouse Management solution. For comparison, in Q1 2007, we closed 3 large deals; 2008, 4; 2009, 0; and Q1 2010, we closed four $1 million-plus transactions. Our revenue goals are based on closing three to four $1 million-plus deals in each quarter. Our 2011 pipeline for potential $1 million-plus deals is more than healthy enough to support that pace. With anything close to normal close rates, we would meet or exceed the 3 to 4 per quarter requirement. As confidence in making larger capital commitments to supply chain transformations returns, I'm quite confident our win rate on those deals will continue lead the market. In Q1, about 70% of our license revenue was with existing clients and about the same figure came from Warehouse Management systems. Retail, along with consumer goods and third-party logistics, once again accounted for more than half of license revenue. During the quarter, we took more than 65 client sites live on our solutions. I'm quite happy to report that we now have 7 clients and 17 sites live on our platform-based Warehouse Management system, which we released in 2010. At the end of the first quarter, we had more than 1,900 employees around the world, which is a modest increase from the end of 2010, and up more than 100 from one year ago. We had 56 sales representatives at the end of the quarter, the same as the year-end number. Sales and sales management headcount totaled 65, down 1 from December. Over the balance of 2011, we plan to add about 100 people to our staffing, primarily in professional services roles. Next month, we'll host our annual customer conference, which we call Momentum 2011 at the Hilton hotel in San Diego, California. The conference theme is "Platform Thinking Activated," and the content is all about the advantages created by having our complete suite of solutions on a common supply-chain process platform. We'll be showcasing numerous ways customers can leverage Manhattan's platform approach to lower total cost of ownership and extend market advantage. Much of the material will be presented by our customers, and registrations are up nicely compared to last year. We're looking forward to sharing a good time and a lot of fun and information with our global customers. So let me close our prepared remarks with a brief summary. We're fully focused on doing everything in our power to close million-dollar license revenue contracts. We're all well aware that license revenue is the most important leading indicator of the health of a software company. But other than our result on that metric, I'm quite pleased with how our company is performing. Our other revenue categories are quite healthy and growing. Our sales pipelines are large and expanding. Our expense management is diligent. Our investment in R&D and innovation is considerable. The market reception to our solutions is strong and our relative competitive strength is increasing. Based on all of these factors, I believe when the inevitable happens and companies more aggressively act to transform their supply chains, Manhattan's license revenue will reflect winning a very healthy majority of these large opportunities, and our overall financial results will show even greater strength. So that wraps up our comments about Q1. Operator, we'll now take questions.

[Operator Instructions] Your first question comes from the line of Terry Tillman from Raymond James. Terrell Tillman - Raymond James & Associates, Inc.: I guess, Peter, Dennis, can you talk a little bit more about the services backlog because I guess that's been the shining star here over the last couple quarters? Anything to quantify the strength of the services pipeline. Is it accelerating, or is it still strong? But are you starting to see it ebb a bit because of the recent license weakness?

Yes, I'd be happy to take the first crack at that. Terry, it's Pete. Actually, our services pipeline strength actually is consistent with some of the weakness we've seen in license revenue. Clients of Manhattan Associates and I believe others continue to invest modestly in enhancing what they currently have installed, either with our systems or other legacy applications, modifications to improve business performance, upgrades to improve business performance and adapt to newer technologies are some of the motivations for our strong services revenue. We believe we'll see that continue even with a somewhat disappointing license revenue result in Q1. We believe optimistically that as the economy improves, we'll get even further demand for our services capability. I mentioned in my prepared remarks, we're expecting to add about 100 people over the balance of the year. And most of those folks will be in professional services roles. So we have a nice backlog of work we need to do to continue to meet our customers' demands, and we expect as the economy continues to make slow but consistent improvements that the demand for our services will grow similarly. Terrell Tillman - Raymond James & Associates, Inc.: Okay. So I guess on the services side, I mean sometimes there can be debates, the services as a leading, incidental or lagging indicator. So in this case, you're saying it's more a reflection of the environment and there's still frugalness and doing more with what you have and optimizing what you currently have. Is there nothing to be said in terms of the recent resiliency in services strength to anything that's a leading indicator? Because what I'm getting at is about idea as this platform initiative continues to take hold that, yes, it's going to maybe drive some services and some upgrades, but, also, it can lead to other module sales, thus helping license.

Sure, sure. Obviously, Terry, that is one of the key points behind our strategy. We're quite optimistic given the activity that's taking place now, a request for proposal, demonstrations, site visits and so forth, that our platform strategy resonates very well. And as companies begin to make larger investments in transforming their supply chains, we'll be significant beneficiaries of that. You may recall, Terry, we've talked about in previous conference calls that our services revenue is largely made up of 3 components. One component is installing software for and configuring software for new sales. Second component is upgrades for existing customers. And a third component is enhancements or extensions to further enable existing customers to get greater benefit out of their software. In this kind of environment where, at least in supply chain, where there are significant additional capital commitments required to transform supply chains, the new install demand is a little less than we had hoped. But in that same environment, the demand from clients for the other 2 components, enhancements and upgrades, continues to be strong and we would expect that to continue. And frankly, we think that is greatly aided by our investments in our platform. The demands of existing customers or the request of existing customers to upgrade from some of our previous releases to our platform-based WMS release is quite encouraging. So we believe we have ample opportunity to continue to perform well in our Services business and look for the upside as the license revenue market gets stronger. Terrell Tillman - Raymond James & Associates, Inc.: Okay. And I guess, you guys give a lot of color in terms of how to build or update our models. And I know you all don't want to give quarterly specific license, but you give us parameters. And I guess after the first quarter sluggishness and you talked about third quarter seasonality, I mean should we be thinking that if the License business is to see resurgent demand, it's going to be just heavily weighted in 4Q? Or is there anything that can be said about potentially 2Q as we're doing our models that we could see some sort of notable uplift from the first quarter levels on the license side?

Yes, Terry, as you know, Q2 and Q4 historically have been stronger revenue quarters for us; Q1 and Q3 weaker. We certainly would expect Q2 of this year to be noticeably stronger than Q1 of this year. So we would expect a nice improvement in Q2 license revenue from the Q1 result. Do I believe we'll be able to recapture everything we had hoped to land in Q1 and Q2? Probably not. I believe that would take longer, but there is always that possibility. But we're very focused on making sure that our win rate stays quite high, and that we'll continue to do everything to drive customer satisfaction. And the selling and marketing teams continue to be quite engaged in driving customer support for Manhattan's applications.

Yes, Terry, this is Dennis. I mentioned in the script that we expect total revenue to be roughly about equal for the last 3 quarters. The point in that being is our forecast is not a hockey stick in the back half of the year. Terrell Tillman - Raymond James & Associates, Inc.: Okay. But you're not necessarily shifting around the components on the top line. You're still looking for kind of what you had been thinking internally before on your license growth as well as in the services and then hardware side. Or has there been any shift, at least for your all's internal models, on those 3 line items?

More or less similar, Terry. Obviously, with the disappointment in Q1 in license, it may be some shift. But directionally, I think the initial expectations hold.

[Operator Instructions] Your next question comes from the line of Mark Schappel from Benchmark.

Pete, starting with you, given that this is the second consecutive quarter of trouble on the license line with the large deals, what gives you confidence that your close rates on these deals is going to improve in the next quarter or two?

Yes, it's a great question, Mark. I don't have a crystal ball to help us with when these deals will close. What gives us confidence is our win rates and the deals that have closed, both throughout 2010 and Q1 2011, are very high, so we feel very good about our top line position with prospects and others. In addition, we have seen a lot of new activity in the sales pipelines. For instance, in the first quarter, we saw a very nice uptick of additional interests of $1 million-plus deals within our sweet spot of retail supply chain transformations. Now can we more accurately forecast when those deals will close? Probably not. There's still I think a little bit too much noise in the marketplace. A couple of those could close in 2011. A few more will probably close in 2012. But the activity level is picking up, and the support we're getting for our platform strategy is very encouraging. I don't have a very good sense of when that delay or that lack of sense of urgency will mitigate, but we're cautiously optimistic. With each new drop of positive feedback from the marketplace, we get more and more enthusiastic. As I said in my prepared remarks, if we can get the license revenue closure rate to improve, our financial results, we believe, will be quite impressive.

Okay, fair enough. And then in the past, when gasoline prices have jumped up, your customers have paid a little bit more attention to your transportation planning products, looking to reduce their gas costs at the margin. And with gas prices bumping up to about $4 a gallon now, I was wondering if you're seeing similar customer interests like you've had in the past.

Yes, the interest is starting to pick up, Mark. It's kind of interesting, fuel prices had bounced around quite a bit in the past 12, 18 months, 24 months. And depending upon your perspective, that will influence some of your strategies. These systems though do take a little bit of time to implement and so forth. So I would expect, as has been the case in the past, there's a little bit of a lag between spikes in oil prices and the demand for enhanced transportation solutions, particularly the type that Manhattan offers with significant optimization algorithms embedded in them. So we're optimistic over the balance of 2011 and looking out further, that there'll be considerable demand for transportation solutions. Again, we think we have a meaningful competitive advantage in that space with our transportation solution on the same supply chain process platform as our Warehouse Management and each of our other applications and believe that we can bring enhanced value to that opportunity to minimize the impact of higher oil prices.

Okay. And then finally, I was wondering if you can just provide us a little bit of an update of that large project with a hardware customer and just give us an idea of how that project's proceeding.

Yes. It's going well, Mark. It's progressing right on schedule. They're pleased at this point and we're pleased with the progress, and we're optimistic that everything will maintain that kind of momentum. But so far, it's going quite well.

There are no further questions at this time.

Thank you, everyone. We greatly appreciate your spending some time with us this afternoon, and we look forward to catching up with you in about 90 days. Good evening.

This concludes today's conference call. You may now disconnect.