QAD Inc.
Q1 2020 Earnings Call Transcript

Published: 30 May 2019

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the QAD Fiscal 2020 First Quarter Financial Results Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] And as a reminder, the conference is being recorded. I would now like to turn the conference over to Kara Bellamy, Chief Accounting Officer. Please go ahead.

[Kara Bellamy:]

Hello, everybody, and welcome to today’s call. Before we begin, I’d like to ensure that everybody understands that our discussion may contain forward-looking statements that are based on certain expectations and analyses. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. QAD undertakes no obligation to revise or update these forward-looking statements to reflect events or circumstances after the date of this call. For a complete description of these risks and uncertainties, please refer to QAD’s 10-K and 10-Q filings with the Securities and Exchange Commission. Please also note that during this call we will be discussing non-GAAP pretax income, which is a non-GAAP financial measure as defined by SEC Regulation G. A reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measure is included in today’s press release, which is posted on the Company’s website. Now, I would like to turn the call over to our CEO, Anton Chilton.

[Anton Chilton:]

Good afternoon and thank you for joining today’s call to discuss QAD’s fiscal 2020 first quarter results. Joining me on the call are Pam Lopker, our President; and Daniel Lender Chief Financial Officer. Our first quarter showed we meet guidance for both subscription and total revenue. Shortly after the end of quarter we held our annual global user conference, Explore, where the focus this year was on increasing levels of disruption and change in manufacturing. We discussed how QAD’s solutions help companies sense, plan and act swiftly in response to changes in their industries and business models. To that end, at the Explore event, we launched QAD Adaptive Applications receiving a very positive reception from our customers and analysts. The quarter also saw strong momentum in the conversion of our existing on-premise customers to QAD cloud solutions. I’ll now turn it over to Daniel to discuss the financial results.

[Daniel Lender:]

Thank you, Anton. First quarter total revenue and subscription revenue met our guidance and both GAAP and non-GAAP pretax results exceeded our guidance with small increase – with small decreases across all expense categories. Our planned investment in sales and marketing to drive new customer acquisitions remains on track. For the first quarter, currency negatively impacted total revenue by $3.3 million, compared with last year, but had a negligible impact compared with the prior sequential quarter. Our bottom-line was negatively impacted by about $800,000 versus last year. My comments today about growth rates are given on a constant currency basis unless otherwise noted. First quarter revenue was $78 million, compared with $86.2 million last year, which was predominantly as a result of expected declines in our Professional Services business, which I will address in a moment. Subscription revenue grew 20% and was 32% of our business for the first quarter of 2020. Last quarter, we began providing annualized subscription billings growth statistics. Over the last 12 months, our subscription billings grew by 28% with three year CAGR subscription billings growth at 34%. Subscription margins for the quarter were 63%, up from 62% a year ago. As a result of continued investment in cloud growth and infrastructure, we expect subscription margins to stay at current level or make a small improvement throughout the remainder of this year. Our goal remains to improve subscription margins by 1 to 2 percentage points per year over the medium-term. Maintenance and other revenues were down slightly on a quarter-over-quarter basis to $29.9 million from $31.5 million. On a constant currency basis, maintenance revenues were down by $400,000. We expect to continue to see the effects of conversions to the cloud on our maintenance revenue line. Professional Services revenue was $18.4 million compared with $26.9 million from last year’s first quarter. As expected, the decline primarily resulted from a large multi-site global implementation project that was substantially complete in Q4. We expect Q2 services levels and margin to be similar to this quarter, with improvement in the second half of this year. Services margins were negative 5% for the first quarter as anticipated and we will continue to expect breakeven services margins for the full year. License revenue for the fiscal 2020 first quarter was $4.5 million, compared with $6.3 million last year. In the first quarter, we recognized revenue from one deal greater than $1 million and in recent quarters the majority of our license revenue came from existing customers. Total revenue by vertical for the first quarter was

[Anton Chilton:]

Thank you, Daniel. As discussed on our last call, this year we are investing in sales and marketing with a focus on building substantial lead generation and new business development capabilities. This investment is already generating a solid pipeline and our funnel is increasing. However, we are seeing new deals taking a little bit longer to close. We had 15 new cloud bookings this quarter with ten of those conversions of existing customers and five new customers. Although we continue to see about 50-50 mix between conversions and new customers on an annual basis, this quarter was more heavily weighted towards conversions. Looking forward, we will continue to increase our emphasis on winning new customers away from our competitors as we see substantial opportunity there. This has been our biggest first quarter cloud bookings result ever and is double what we did last year. That said, we didn’t quite reach our internal goals due to some deals slipping into the next quarter. Our cloud funnel remains strong and is over 25% from this same time last year. As expected, we saw a significant drop in professional services revenue now that a large multiyear implementation is substantially complete. Looking at the quarter from a geographic perspective, North America had a very strong performance bringing in a significant proportion of the bookings. EMEA was down as a percentage of bookings over the same period last year. However, the challenges discussed in our last call are being addressed and we expect to see improvements in funnel and results over the next few quarters. Asia Pacific and Latin America also had quiet quarters when compared to last year. A virtual breakdown to our drop in performance for our automotive sector, likely a reflection of increased caution in that market in general without real vehicle production volumes down globally. Our electronics and industrial sector had stellar performance this quarter including bringing in our largest deal of the quarter. Life sciences remained steady and no major change in CP and food and beverage verticals. Our QAD DynaSys division with its world-class demand and supply chain planning solutions had another very strong quarter as did our QAD Precision division with our global trade and transportation execution solutions. Indeed with all the disruption caused by ongoing tariffs and geopolitical uncertainties, we expect to see continuing demand for managing supply chains in global trade more effectively. On the solution side of the business, we have more than 35 customers now working with QAD adaptive ERP formally known as Channel Islands, with 26 LIBOR in the process of going live in the next few months. We have a growing pipeline of customers and prospects that expect to adapt – adopt – or adapt the ERP solutions in the near term. In the QAD Labs, we continue to expand the capabilities of our shop floor execution solution. We are adding advanced warehousing capabilities and have launched an initiative in the robotic process automation space. We will continue to invest R&D effort in digital transformation and the application of advanced technologies to support efficient and effective manufacturing processes. I’ll now hand over to Pam.

[Pam Lopker:]

Great. Thanks, Anton. I would like to give another summary of QAD cloud for Q1. So in Q1 we saw a pickup in conversion which is after Q4 we could somewhat nine conversions, Q1 had 10 conversions and five net new customers. As Anton indicated, it was our best Q1 ever for cloud bookings. All regions contributed cloud bookings with North America leading. This quarter industrial segment led all the segments. To highlight some of the new industrial customers, we received a new order from an Italian subsidiary of an American Fortune 100 corporation which manufactures machinery. This deal represents the continued standardization of QAD by this customer. We also received an order from a French multinational corporation that produces a variety of construction and high-performance materials. In addition, we received an order from a smaller U.S. based company that manufactures fire protection and sprinklers, steel pipes. As with all the cloud customers in the release QAD adaptive applications played a key reason for the conversion – for their purchase as well as a conversion to the cloud. I’d also like to give a little more color on our Explore Conference, particularly from a product perspective. It was our highest rated Explore event to-date. And I believe a lot of that has to do with the availability of QAD adaptive ERP, which is designed to address the greatest challenges manufacture's face today, change and uncertainty. We don’t have to look hard to find increasing levels of disruption in our customers’ industries, the way they manufacture to deal geopolitical environment in which they operate and of course the economy with the ever changing uncertainty regarding tariffs. Now more than ever, manufacturers need to be able to rapidly respond to changes. The customers demonstrated a strong interest in our new production execution in our adaptive application. 31% of the attendees visited our hands-on session and requested follow-ups. 97% of customers said they would recommend the Explore conference to colleagues and we are looking forward to seeing them next year in Las Vegas, May 11 through 14. Thanks, Anton. Back to you.

[Anton Chilton:]

Thank you, Pam. So looking forward, as I said earlier, our investments in sales and marketing are starting to payoff in terms of lead generation. In fact, our lead flow volume in Q1 is up 37% when compared to the same period last year. We're also ahead of the targets that we set for marketing and lead generation teams. Technology and geopolitics continue to drive change and uncertainty in manufacturing markets around the world. Legacy ERP applications don’t provide businesses the flexibility and agility needed to react and rapidly respond to these changes. As Pam said, with the launch of QAD Adaptive Applications, our customers and prospects have access to solutions in the cloud that will support this rapid response. This will be a key source for ongoing growth of our cloud business. We see a lot of runway in replacing legacy ERP applications and our total addressable market for cloud solutions is increasing. However, we do see an increase in short-term risk with some deals taking longer to close. We think this is around tariffs and some negotiations and geopolitical situations around the world and at this point though we do not expect this to affect longer term goals. We will now take questions live. Operator, can you please give the instructions for questions?

[Operator:]

[Operator Instructions] And for the first question, we will go to Bhavan Suri at William Blair. Please go ahead.

[Bhavan Suri:]

Hey guys. Thanks for taking my questions. I guess, I'll just dive into the last comments and couple it with the challenges you saw in Europe last quarter. I guess, just, as you think about the businesses as a whole, are you seeing any macro pressure to raise tariffs, you talk about sort of a broad based may be a little bit of a slowdown in some areas. I just want to get some color on what exactly are you seeing and is it specific to a region, is it specific to macro, is specific tariffs between China and the U.S? And then, how is your business tracking vis-à-vis the changes you’ve made, you brought in sort of a new Head of Sales from Chicago, Dublin office this year to sort of oversee that. So just to understand how that’s playing out. Thank you.

[Anton Chilton:]

Thanks, Bhavan. Yes, so I’d say, while there is a little bit of caution in there would remind us that we just did the biggest Q1 bookings quarter ever. So, business is there and we are closing it. What I would say at the macro level, we are not seeing broad responses to some of the uncertainty that we see there. I would say that selective customers are being a little bit more cautious and that’s based on their specific businesses and their management philosophies on what’s going on. We do believe that some of that is generally around the tariff negotiations plus some of the political uncertainties we are seeing what’s happened with Brexit and so on. So, but it would be not right to say that it’s completely in one segment. It’s specific customers across a range of segments that we are seeing. And as an example, automotive, yes, there is a slowdown of vehicle production that everybody is aware of. But there is still some very bright spots in that and we still got some customers that are very active some that are less. So, I’d say in response to that question, it’s not a general trend, just a little bit more caution in some spots. In terms of how that’s impacting the business and how we are addressing, I think we are working to plan in the EMEA. We identified the issues that we discussed on the last call. We’ve got recruitment plans underway there. We’ve made a lot of hires there. We still got a few more to go. We made a few more changes around the organization. For example, a new VP of our services organization, our marketing organization and so on. So, some changes, organizationally and adding in some more resource to help us boost that and we see that being on track. You probably are not going to see the results flow through until later in the year. But certainly internally against all the targets we set where we are comfortable with where we are at. I think the overall condition for the QAD business, the funnel continues to grow. As I said it’s over 25% up from the same period last year. We’ve seen the lead flow go up in Q1. So, we are confident that we can get and remain on track for the year guidance as Daniel discussed.

[Bhavan Suri:]

Got it. Got it. That’s helpful. I guess, I’ll touch on one more. One of the things about the cloud business if you think about that, we are talking about it being 50-50 new and existing customers, and we are talking about the focus on new logos given you can’t force existing customers move over as well that shift of incentive. I'd like to get a little more color if I track forward in two or three years from now and you look at the pipeline for the cloud business, how would you expect it to look and how do you expect to sort of revenue break out to be, sort of think through that process?

[Anton Chilton:]

Yes, I think for the short-term, we see that 50-50 going there. We still got a big runway in our installed base, as well as a big runway of market share we can go and grab from legacy ERP competitors. I would expect over time that, the new business is going to create a greater proportion, because as we have converted more and more of our customers obviously, there will be less of them to go. And so, we started to model that out over kind of three to five year. But it’s that kind of timeframe I think we are talking about before we see a significant shift in the proportion to new business.

[Bhavan Suri:]

Got it. Got it. But that the – that I got to touch on one more. But if you think about that business, you converted customers to the cloud, but it’s been a pretty steady at a 30 or something whatever the number is customers a year, and I wonder that’s going to be a hockey stick at some point either because they come up for a hardware refresh or a software refresh or something and there is going to be the obvious we should move the cloud at some point. If you were to think about that acceleration and you think about timeframes, is that like five years out, ten years out, do you have some idea of how you would think about sort of where that J curve happens on that move from existing on-premise customers are paying for maintenance to cloud?

[Anton Chilton:]

So, yes, I think as we are increasing our sales force and lead generation capabilities and we are doing that both in the installed base, as well as the new business. In fact, we have a team that we have set up that looks at lead generation in the installed base specifically around conversions. So, we will be putting more and more effort into pushing the conversions very, very heavily. We see a number of different catalysts for people converting away from on-premise. Certainly, hardware and burning platforms around support could be one of those. Another common factor has been where the change in management with a focus on getting IT folks really focused on business models and leveraging technology versus operating the technology and keeping the systems up and running. And then, conversely on the competitive side, we see some competitors that are bringing to end of life some of the current versions and there isn’t necessarily a migration path to their lightest offering and we think that will drive some of the new business stuff. So, we really see big runway in both those spaces.

[Bhavan Suri:]

One last one for me. Any big sort of replacements this quarter and who are they guys? Thank you. And nice job on the billing numbers.

[Anton Chilton:]

Yes, so, I think the – Pam highlighted one customer that’s continuing to move away from its legacy ERP provider and to continue to consolidate on to the QAD platform. The other one as you referred to is the French organization and they have shown more signs of adopting the QAD platform and indeed moving away from one of our biggest competitors too. So, yes, definitely a couple of significant ones there for us.

[Pam Lopker:]

Those are both companies that have paid over previously committed to an SAP kind of worldwide platform, so.

[Bhavan Suri:]

Thanks a lot.

[Anton Chilton:]

Thank you.

[Operator:]

Thank you. And our next question will come from Brad Ryback at Stifel. Please go ahead.

[Brad Ryback:]

Great. Thanks very much. I guess I am a little confused. Given that there are so many issues outside of your control impacting the overall demand environment, why not take the opportunity to reduce subscription expectations for the back half of the year? Thanks.

[Anton Chilton:]

So, as I said earlier, Brad, I think the funnel continues to grow and lead flow is up and so, that’s giving us confidence that the deals are there to close and we did have the best Q1 bookings quarter we’ve ever had. We did introduce a note of a little bit more caution around some of the deals that have slipped and so on. So, we will be keeping a close eye on that. But right now, that’s not in sufficient or all sufficient magnitude for us to revise the guidance.

[Brad Ryback:]

Okay. Thanks. And switching gears, when a customer moves to the adaptive apps, what type of uplift in revenue do you see from that customer? Thanks.

[Anton Chilton:]

So from – they – if they are in the cloud, they get access to the adaptive applications. However, there are additional modules now that they also get access to our already proving popular even in earlier in their lifecycle. So the production execution module that we have is an example of that. You need to be on lighter versions of the QAD applications to take advantage of that. And that is a subscription model or module I should say that’s purchased through subscription and we expect to see more and more of that as we extend applications around our enterprise platform that we have introduced with adaptive applications, we will see more and more of those things coming. So, the move to the adaptive platform itself won’t necessarily generate money, but around that we’ll have additional modules and capabilities that will be chargeable on a subscription basis.

[Pam Lopker:]

I think there are several capabilities, for instance of the embedded analytics that have – I think and ties more management to these users. We have a really, really good requisition approval in mobile capabilities that again ask to drive more users. Today if we look at half of that percentage of an enterprise, users of QAD App are in the component area specifically about 20% and moving up into the end product, med-device type products, it’s typically about 45% of the employees. So, of course, our goal is to move that up even further. In the September timeframe we will be releasing the first release of our CRM product built on the platform and we are already seeing tremendous interest on that from our user conference. So we are really looking at generating a bigger percentage of users using our product.

[Brad Ryback:]

Excellent, thank you very much.

[Pam Lopker:]

Thanks.

[Anton Chilton:]

Thanks, Brad.

[Operator:]

And we go now to Zach Cummins with B. Riley. Please go ahead.

[Zach Cummins:]

Hi, good afternoon. Thanks for taking my questions. Just starting off it sounds like your pace of hiring in the sales and marketing group is pretty well in line with expectations. So, how should we anticipate this really trends over the next few quarters? Is there still some additional hiring that you are planning on doing in the upcoming quarters?

[Anton Chilton:]

Yes, there is. So, we’ve done a substantial portion of it. Indeed we last quarter ran a large group camp here in Santa Barbara to welcome the new sales and marketing people in the organization and get them up to speed. We are running another one of those in - so it’s mid to late July. So, there will be another bunch of people out here. And then, that will start to kind of tail off in the second half of the year and that’s where we expect to see the lead-gen results flow through from marketing leads to sales leads to opportunities and then, ultimately to close deals. So, again, from a visibility perspective start to expect to see that, both in funnel terms and deal terms towards the back end of the year.

[Zach Cummins:]

Understood. And in regards to the new reps, what is the sort of timeline that you are putting on them to get to full productivity?

[Anton Chilton:]

So, the way we measure them, we exclude them from a, let’s call it, internal productivity metrics in sales for the first six months with their onboard. That doesn’t mean we don’t expect them to be productive, but that just allowed us to give them the training and the exposure they need to our solutions, philosophies, customer base selling message and everything else. And then after that, we expect them to be fully productive within a six month period.

[Zach Cummins:]

Understood. And final question for me, it sounds like you are doing a really good job of the lead generation side of generating the new opportunities. But what in your mind really needs to be done to be able to close these deals with your customers as you go through these next coming quarters?

[Anton Chilton:]

Yes, it’s to follow-up and obviously the execution. So, the marketing organization and the new structure we put in place, as you rightly say, is generating that. It’s now getting those sales executives focused on those leads to follow-up and creating the compelling messages that convert the interest into real opportunity and then into – ultimately into a real deal. We like the fact that with the disruption that’s going on, that is creating more and more of an incentive for people to move away from all the ERP that’s kind of stodgy and hard to change and expensive to change to one that’s more rapid and agile. And so that’s the message that we are really driving home with prospects and customers is don’t wait for change to come at your door. Get ready for it and be on an agile platform that allows you to respond quickly. And so, that’s kind of the core message that we are pushing out there to just try and get people to move.

[Zach Cummins:]

Understood. Well, thank you for taking my questions and best of luck in the coming quarters.

[Anton Chilton:]

Thank you, Zach.

[Operator:]

Thank you. That does conclude our Q&A session for today and we will turn back to Anton for closing remarks.

[Anton Chilton:]

Okay. Well, thank you everybody for today’s call. We appreciate it and we look forward to updating you with our Q2 results in the future.

[Operator:]

Ladies and gentlemen, this conference will be available for replay after 4