Manhattan Associates, Inc.
Q2 2008 Earnings Call Transcript

Published: 23 Jul 2008

[Operator:]

Good afternoon. My name is Abigail, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Manhattan Associates second quarter 2008 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions). As a reminder, ladies and gentlemen, this call is being recorded today, July 22, 2008. I would now like to introduce Mr. Dennis Story, Chief Financial Officer, and Mr. Peter Sinisgalli, Chief Executive Officer, of Manhattan Associates. Mr. Story, you may begin your conference.

[Dennis Story:]

Thank you, Abigail, and good afternoon, everyone. Welcome to Manhattan Associates' 2008 second quarter earnings call. Before we launch into the results discussion, 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 risks 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 2007, 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 insights into our profitability, exclusive of unusual adjustments. Our Form 8-K filed today with the SEC and available from our website, www.manh.com, contains important disclosures 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 will turn the call over to Pete.

[Pete Sinisgalli:]

Thanks, and welcome to our call. I'll start the call by taking you through some of the highlights from the quarter and the first half. Dennis will then get into details of our financial results. I will follow with additional details about our business and provide an overview of our outlook for the balance of 2008 and our financial guidance, and then we'll both be happy to answer your questions. As you've seen our press release issued today, our second quarter earnings per share was in line with our guidance, and we are on plan to deliver full year EPS growth of 18% to 23% over 2007. All things considered, we're pleased with our performance across key metrics and functions. From a license revenue growth perspective, sales cycles have lengthened somewhat, and as a result, license revenue for the quarter was down about 17% versus Q2 of the prior year. However, from a sales execution perspective, our competitive win rate in Q2 was quite strong with a few deals being delayed, but not lost. We also have an attractive pipeline going into Q3, and for the second half of the year. From a consolidated revenue perspective, solid services revenue, showing 12% growth versus the prior year, combined with license revenue growth to show 1% revenue growth overall versus Q2 of 2007. From a margin perspective, while it is quite a challenge to offset the reduction of 90% gross margin license revenue, we were able to do so largely through a strong services margin and operating expenses lower than the prior year. As a result, we were able to report an operating margin for Q2 of just over 17%, which was flat with Q2 of last year. Operating profit and net income were up over Q2 of last year, and adjusted earnings per share, due in part to a lower share count, was up 17% versus Q2 of '07. Looking at our performance over the first six months of 2008, compared to the first six months of 2007, we delivered growth across the board as follows

[Dennis Story:]

Thanks, Pete. Manhattan delivered record revenue, operating profit, and earnings per share performance in the second quarter. Before I cover the he details, here are a few key takeaway points, summarized. First, record EPS. We reported record Q2 2008 adjusted EPS of $0.42 today representing a 17% increase over Q2, 2007 adjusted EPS of $0.36. Second, record revenue

[Pete Sinisgalli:]

Thanks, Dennis. We continue to be pleased by our ability to extend our success and optimizing supply chain beyond our heritage in warehouse managing systems. Of the $19.4 million in license revenue for the quarter about half was attributable to sales of warehouse management solution and half to our other solutions. While W M.S. license revenue in the quarter was flat with the prior year, transportation life cycle management more than doubled, while our planning and forecasting, and inventory optimization solutions grew more than 10%. Offsetting growth from these solutions were declines in trading partner management and performance management, solutions now replace with enhanced offering an extended enterprise management and supply chain intelligence, both released in June. Labor management also showed a slight decline after several quarters that have placed the solution in a leading market share position. We are particularly excited about our opportunities in transportation life cycle management. With the price of oil at an all-time high, making transportation more efficient is top of mind for most supply chain executives. And our market leading TLM solution could help them achieve that. About 60% of second quarter license fees were generated from new customers and the remaining 40% came from our existing customer base. The retail, consumer goods, and logistics service provider verticals once again combined for more than half of license revenue in the quarter. We recorded three deals in the quarter with recognized license revenue of $1 million and more, two of them with new customers, two were for transportation life cycle management and one was for distribution management. Also notable in the quarter was our first meaningful license sale in India. Our professional services organizations around the globe continued to perform well. In addition to posting strong financial results, the teams continue to drive improvements in customer satisfaction. In the first half of 2008, our global services teams helped customers go live with our solutions in more than 170 sites. Our ability to help customers create and execute sophisticated supply chain strategy continues to strengthen this quarter as we issued new releases of several products in June. These include warehouse management for open systems, warehouse management for system I, inventory optimization, supply chain intelligence, and billing management. Our R&D teams around the world did an exceptional job of meeting our objectives for these releases, delivering quality software on time and on budget. Headcount at the end of the quarter was about 2,250, about flat with the end of March and modestly above the headcount at the end of 2007. We increased our direct sales rep headcount by six during the quarter from 65 to 71. Five reps were added in the United States and one overseas. We expect these additions to enable us to take advantage of our solid pipeline and strong competitive market position. Let me now shift to our view of the third quarter and full year. While our third quarter has historically been seasonally soft, we expect to post a good third quarter in 2008. Our license revenue pipeline for the quarter is quite encouraging. No guarantees on what we will close, but we're optimistic when viewing the in-quarter pipeline. Moreover, the other parts of our business continue to perform well. As a result, for the quarter we expected adjusted earnings per share to be in the range $0.34 to $0.42. We posted $0.34 in the third quarter of 2007, so our guidance reflects EPS growth of between zero and 24%. For the full year, we are confirming our EPS guidance. We continue to expect adjusted EPS in the range of $1.54 to $1.60 per share. The annual guidance range represents growth over 2007 of between 18% and 23%. The supply chain management competitive landscape continues to evolve, and we believe we are uniquely positioned in this space. Over the past six months, and realistically over the past 24 months, perhaps even longer, we believe no competitor has closed ground on our lead in the supply chain solutions market and we believe we have further distanced ourselves from essentially everyone. Moreover, we believe the optimization of supply chains is gaining importance as an operating imperative. In the United States, in 2007, transportation cost rose 6%, and inventory costs rose 9%. Logistics cost in the US last year totaled $1.4 trillion, or just over 10% of our entire growth domestic product, and continue to rise in the first half of 2008. The rapid rise in the price of oil is putting tremendous pressure on all parts of the supply chain. When oil, and therefore transportation, was cheap, our off shoring made sense to leverage lower labor cost. But as transportation cost rise, the fundamental benefits of off shoring are being called into question. These questions have important implications for where to locate manufacturing facilities, where to locate warehouses, how much inventory to carry at each node of the supply chain, how best to manage company-owned trucks and common carriers, how to manage labor, and most important, how to optimize all of these supply chain components simultaneously, while also improving customer service levels and satisfaction. Managing supply chains in these changing times will require companies to significantly adjust their supply networks, and they will be turning to experts for help. We believe the more supply chains change, the better for Manhattan Associates. We believe no company is better positioned than we are to help organizations adjust and realign functions across their supply chains to increase their market competitiveness. Our complete suite of supply chain optimization solutions on our common business process platform, which we refer to as supply chain optimization, planning through execution or SCOPE creates a sustainable competitive advantage for Manhattan Associates. So to summarize, we had a respectable second quarter and a solid first half of 2008. We are executing well and have confidence in our second half outlook. We believe we are very well positioned to continue to lead the supply chain management market, and intend to capitalize on that opportunity. With that, operator, we'll now take questions.

[Operator:]

(Operator Instructions). Your first question comes from Michael Huang of ThinkPanmure. Your line is open.

[Michael Huang:]

Thanks very much. Hey, guys.

[Dennis Story:]

Hey, Mike.

[Michael Huang:]

Few questions. So, in terms of the large deals that slipped out of the quarter, just wanted to get a perspective on, was this similar to what happened in Q4, or was this something different?

[Pete Sinisgalli:]

Generally speaking, it was pretty similar. I would suggest to you, in this particular quarter, with a difficult macro environment, companies wanted to make sure they're making capital expenditures with prudence. I think there was a little bit greater emphasis on the overall economy in the June quarter than, perhaps, in the December quarter. But I would suggest overall, it was fairly similar number of important business prospects and partners making sure they are prepared to make the capital investments.

[Michael Huang:]

Okay. And then, given what you saw with sales cycles and close rates in Q2, I'm assuming that you've delved that back somewhat for Q3 and through the rest of the year. But if sales cycles and close rates are what you saw in Q2, would that imply the midpoint of EPS guidance?

[Pete Sinisgalli:]

More or less. A large deal in our company makes meaningful difference in earnings per share. So I would suggest our assessment at the moment is sales cycles in Q3 will probably not be similar to the sales cycles we experienced in Q2. So we're not expecting an acceleration in close rates, nor a lengthening of sales cycles, so I would say it would be comparable to what we saw in Q 2. And we believe that with the magnitude of a in-quarter pipeline we have in front of us, we are comfortable with the guidance range we've provided.

[Michael Huang:]

Okay. And then, just in terms of the momentum user conference, we were there. It seemed pretty successful. What was the biggest take-away from that user event, and how does that impact Q3, do you think?

[Pete Sinisgalli:]

Well, actually, we were quite pleased with both the turnout at the conference, as well as the energy at the conference. We thought the feedback from our customers and the prospects was quite positive. One of the takeaways we had coming out of that meeting was, we were even more optimistic about the balance of 2008 for our financial performance, and importantly, the outlook for '09 and beyond. So, I would say we were quite enthusiastic about how that conference. And in particular, the enthusiasm our customers showed for solutions beyond our market leading W M.S. solution. The energy around our transportation solution, planning solutions, forecasting solutions and so forth was quite encouraging, and the support for the overall scope, initiative, I thought was quite good. So we were quite pleased with the conference and we're glad you could make it.

[Michael Huang:]

Thanks very much.

[Pete Sinisgalli:]

Thanks, Michael.

[Operator:]

Your next question comes from Brad Reback with Oppenheimer. Your line is open.

[Brad Reback:]

Hey, guys. How are you?

[Pete Sinisgalli:]

Good, Brad.

[Dennis Story:]

Hey, Brad.

[Brad Reback:]

How early in the quarter did it become evident that sales cycles were lengthening and people were taking a step back?

[Pete Sinisgalli:]

Now, it is pretty typical, Brad, to any quarter. More activity than we'd like, as always is coming down towards the end of the quarter, so we really felt pretty good about the quarter, all the way down to the last day or two of the quarter. But I would tell you, we also felt confident in what we reported for Q2. While license revenue was disappointing, down 17% year-over-year, we were quite pleased with the way the rest of our business performed. Frankly, we had anticipated challenges in this environment, and we are managing expenses aggressively, with the license revenue in the neighborhood of what we did post. We would still post a strong EPS result, and as Dennis went through in some of his comments, cash flow from ops was particularly strong. We’re pleased with the DSOs and our services margin, overall margin. Frankly, we think all the metrics, with the exception of license revenue for the quarter, were quite strong. But it did come down to that last couple of weeks of the quarter before the lengthening sales cycle became apparent. But I would imagine any software company with perpetual license sales would give you a similar story almost every quarter of almost any year.

[Brad Reback:]

Have the first few weeks of July been successful in closing up some of those slipped deals?

[Pete Sinisgalli:]

As you know, Brad, we don't comment on that. We do provide our perspective on what the quarter will look like, but we don't provide a specific comment on what's closed and so forth. But I will say that we are quite optimistic about the in-quarter pipeline we have, and know our sales teams around the world are working very hard to close what can be closed, and importantly, deepening our relationship with both customers and prospects. So, as they are ready to make that decision, they'll choose Manhattan Associates as their partner.

[Brad Reback:]

On a percent basis, Pete, how much bigger is the 3Q pipeline versus the 2Q in-quarter pipeline.

[Pete Sinisgalli:]

I am sorry, Brad, but we don’t disclose that as well. Historically, Q2 has been about our strongest license revenue quarter, but I will tell you that we do think Q3 should be a good quarter for us. Typically, it's seasonally slower than Q2, but because of the timing of sales cycles and so forth, we believe Q3 would be a solid quarter for us this year. But we don't disclose the specific pipeline by quarter.

[Brad Reback:]

Okay. And on the expense front, R&D as a percent of revenue is the lowest it's been since 2002. Is this a change in level of investment in the product? Was this a one-time issue related to performance and maybe bonus payments? Help us understand that.

[Pete Sinisgalli:]

Sure. I’d say it's more timing, but only by a percentage or so. We continue to expect to invest somewhere in that 14% of revenue number in R&D. This quarter, we did have some recalibration of some of incentive compensation programs that also helped us in our services marginally. So, those were timing issues, but we do continue to invest meaningfully in our next-generation product. As I mentioned in June, we had the release of five products that we were quite pleased about. There are some, we think, ground breaking new solutions, in particular supply chain intelligence. We think is a very attractive new solution for Manhattan with robust capability, and we will continue to invest in the SCOPE platform in our suite of solutions. So, I do think the somewhat lower R&D, as a percent of overall revenue, in Q2 was more of a timing issue than any specific long-term plan.

[Brad Reback:]

Great, thanks a lot.

[Pete Sinisgalli:]

Thanks, Brad.

[Operator:]

Your next question comes from Yun Kim with Pacific Growth. Your line is open.

[Yun Kim:]

Thank you. I think, Pete and Dennis, you said that headcount in services was down by 20 sequentially. What drove that, and what is your headcount growth planned for that organization for the year?

[Pete Sinisgalli:]

Sure, we will be happy to share that with you. In general, we plan to grow headcount in our services business inline with revenue growth for the services business. So, you should expect as our services business grows somewhere in that, I guess, the second quarter, we grew about 12%, for the first half about 10%. We'd expect reasonable growth in our services business for the balance of the year. So, we generally would expect headcount to grow in about that pattern. Candidly, what we did in the first half of 2008, we had hired a few additional people anticipating the opportunity for perhaps some acceleration in our services business. That didn't happen quite in the time line that we expected, so we were able to over the second quarter, work down some of that capacity that we had stepped up in the first quarter. So, that was essentially the reason for the reduction in about 20 heads in the second quarter versus the first quarter. We did staff up in the first quarter to make sure we could drive high levels of customer satisfaction. We believe we can continue to do that with the 20 fewer heads in Q2, and we're quite pleased with performance there. And I expect if you look over the second half of the year, for services headcount to grow about inline with our expectation for services revenue.

[Yun Kim:]

So, you were able to improve margin in services, while you actually saw some people on the bench, or you able to account for that before you took a hit in the margin?

[Pete Sinisgalli:]

Yes, actually, so what happened in the quarter, Yun, as services revenue grew, we had some attrition, which every services organization is going to have. We chose not to replace the attrition during the quarter, which resulted in about 20 fewer heads, but we did have capacity within the organization to fully staff for this project. So, we were able to deliver on the revenue potential in the quarter with 20 fewer heads.

[Yun Kim:]

Okay, great, thanks. And then also, in terms of seven-figure deals in your sales pipeline, can you just talk about how much you have in those deals in the second half, and whether you need to be more reliant or less reliant on those big deals in second half, versus first half? And then also, if you can just talk about the general trend regarding the deals in your sweet spot range. I believe that's like 250 to 750 K range. How that been trending? It seems like that area has also performing well.

[Pete Sinisgalli:]

Yes, we’re happy to. As I mentioned to Brad, we don't provide specific details on dollar amounts or what's in the pipeline. But I will tell you we have a very nice Q3 pipeline for million plus deals, particularly in the United States. I think the market for our solutions in the US continues to be very strong, although Q1 and Q2 were a little behind what we had hoped for. Overall, pipeline in the Americas is quite strong, and in particular, what we call double comma deals, or million plus deals in the Q1 look quite, in third quarter, and for the second half of the year, look quite good. And we're encouraged that those deals are across multiple products. So, we expect to continue to have great success with warehouse management, as people upgrade and realign their entire supply chain network, but in particular, we think transportation will be a very nice opportunity for us over the second half of '08 and going into 2009. One of the things we're particularly pleased about is that, with the change in the macroeconomic environment, but the increase in the price of oil, with the implications that has for all components of the supply chain, as I mentioned in my prepared remarks, we think supply chain transformations will become even more important and companies will look at all components of their supply chain to re-optimize the way they go to market. We think that impetus will drive very good performance for Manhattan over the next several years. So, we're quite excited about that long-term prospect as well as the outlook for Q2 and Q4.

[Yun Kim:]

Great and then quickly, Dennis, cash flow, the strong cash flow from operations mainly coming from the receivables and accounts payable, accrued liabilities. I'm assuming those are more than one quarter events, or is there more leverage there, or is there leveraging other balance sheet items that we can get squeeze out extra cash flow in the second half?

[Dennis Story:]

The leverage primarily comes from managing aggressively managing receivable collection, Yun.

[Yun Kim:]

Okay, alright. Thanks very much.

[Operator:]

Your next question comes from Mark Schappel with Benchmark. Your line is open.

[Mark Schappel:]

Hi, good evening. Pete, regarding the deals that slipped in the quarter, would you characterize these deals mid-size transactions, or would these be some of the larger million plus dollar type deals?

[Pete Sinisgalli:]

Yes, I’d be happy to give some general color on that. We had a couple deals slip in the quarter. But I will tell you we have a number of deals slip every quarter like every other software company. It's one of the exciting challenges of enterprise software, perpetual license enterprise software trying to move deals along at a fair pace, but also establish great working relationships with your customers and prospects to make sure over the long run you have a terrific relationship. So, we always have a few deals that slip out of the quarter, and every once in a while we get surprised that there's some other deals that come into the quarter that we hadn't expected. I would suggest to you in Q2 we had a number of larger deals, particularly in the US that did not close in the quarter, that we thought could close in Q2. I believe in each of those deals they were merely delayed, don't believe anything was lost, and we're optimistic that over the next couple of months we'll see those come to provision. I know our sales team is quite excited about the second half of the year. We had our midyear sales conference about two weeks ago, where we had the teams together and the enthusiasm about the product suite, the technology platform, pipeline and so forth was quite positive. So, myself and the other executives, who are at the meeting left, that meeting feeling quite good about the long-term health of the company. So, a number of the deals that did slip were larger deals, and we're cautiously optimistic that they will be able to close in the near-term.

[Mark Schappel:]

Okay. And could you also give us a little bit of an update on the supply chain and planning module, and how that product is coming along, the former Evant product?

[Pete Sinisgalli:]

Sure, I’ll be happy to. Generally, there are three products within the suite of solutions we acquired from Evant, supply chain planning, supply chain forecasting, and inventory optimization. Those are the three categories of products. When we acquired Evant, they had a solid offering and inventory optimization you may remember that product previous called replenishment, but they had solid product in that area. Over the past couple of years, we have invested in that solution to build out some future capability. That was not resident, the product that would allow us to compete more effectively with the market leaders in that area. And we believe over the past two years we have made some very good progress with our inventory optimization solutions. Now we still have a lot of work to do, to convince the world that we deserve to be in every deal, and finalists in every deal, and that global brand recognition within the supply chain planning space is evolving for us, but I believe we're making good progress there. As it was evident at the Momentum Conference, Mark, that you attended as well, down in Orlando. I believe that hopefully that senses progress there was visible. In terms of forecasting and planning,