QAD Inc.
Q3 2020 Earnings Call Transcript

Published: 27 Nov 2019

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the QAD Fiscal 2020 Third Quarter Financial Results Call. At this time, all lines are in a listen-only mode, and later we will conduct a question-and-answer session. [Operator Instructions] And as a reminder, today’s call is being recorded.I would now like to turn the call over to our host, Chief Accounting Officer, Kara Bellamy. Please go ahead.

[Kara Bellamy:]

Hello, everyone, 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'll turn the call over to our CEO, Anton Chilton.

[Anton Chilton:]

Thank you, Kara. Good afternoon, and thank you for joining today's call to discuss QAD's fiscal 2020 third quarter results. Joining me on today’s call are Pam Lopker, our President; and Daniel Lender, Chief Financial Officer.Total revenue was in line with guidance for the quarter with an expected decline over the same period last year, largely due to reductions in professional services and license sales. We closed a record number of cloud deals, and momentum in competitive new cloud customer wins continues to be strong. Material improvements in both professional services and cloud margins have contributed to a stronger-than-forecast net income.I'll now turn it over to Daniel to discuss the financial results.

[Daniel Lender:]

Thank you, Anton. Third quarter total revenue and subscription revenue were generally in line with our guidance, while before tax profit, both GAAP and non-GAAP exceeded our projections, resulting from higher subscription and professional services margins.For the fiscal 2020 third quarter, currency had a $1.2 million negative impact compared with last year, and a $700,000 negative impact compared with fiscal 2020 second quarter. Our profit was negatively impacted by $242,000 compared with prior year and $100,000 compared with the second quarter.Please note, that my discussion today about growth rates are given on a constant currency basis unless otherwise stated. Third quarter revenue was $77.8 million compared with $79.6 million last year, primarily resulting from anticipated declines in our professional services business and in license sales.As previously discussed, last year's professional services revenue included a multisite global project. Lower license revenue was due mainly to our transition to the cloud. Subscription revenue grew 16% and accounted for 35% of our business for the fiscal 2020 third quarter. On a rolling 12-month basis, our subscription billings grew by 18% with a three-year CAGR of 28%. Subscription margins for the third quarter grew to 65% versus 64% a year ago. For the fourth quarter, we expect subscription margins to remain at similar levels.Maintenance and other revenues totaled $29.7 million compared with $30.4 million last year. On a performance basis, maintenance and other revenue was down about $220,000 with the decline relating mainly to cloud conversions. Conversions are expected to continue impacting our maintenance revenue line, but as a reminder, the conversion opportunity is generally 3x maintenance, which gives us additional growth potential in a higher dollar margin on an ongoing basis.Professional services revenue was $17.5 million compared with $20.7 million for last year's third quarter. Last year's results included a multisite global project for personnel augmentation services, which has since been completed. Services margins improved to 6%, up from 1% for last year's third quarter and negative 4% for the fiscal 2020 second quarter as a result of ongoing cost-saving initiatives. We continue to expect breakeven services margins for the full-year.License revenue for the fiscal 2020 third quarter was $3.3 million compared with $4.6 million last year. In fiscal 2020 period, there were two license deals greater than $300,000, the same as in last year's third quarter. Total revenue by vertical for the third quarter was automotive, 36%; high tech and industrial, 34%; consumer products and food and beverage, 15%; and life sciences and other, 15%.By geography, total revenue was North America, 49%; EMEA, 29%; Asia Pacific, 15%; and Latin America, 7%. Gross margin for the third quarter improved to 57% from 53% last year. Sales and marketing expense was $19.8 million or 25% of total revenue versus $18.4 million or 23% of total revenue for the last year's third quarter. The increase related primarily to higher headcount.R&D expense amounted to $13.6 million for fiscal 2020 third quarter compared with $13.2 million a year-ago. As a percentage of total revenue, R&D expense was 18% this year and 17% last year.General and administrative expense was $9.2 million or 12% of total revenue versus $8.1 million or 10% of total revenue last year. The increase mainly resulted from the movement of certain personnel into G&A from other areas.Stock compensation expense totaled $2.9 million for the fiscal 2020 third quarter and $2.1 million last year. This brings GAAP pretax income to $1.5 million compared with $3.6 million for last year's third quarter. Non-GAAP pretax income was $4.6 million versus $5.7 million last year.We finished the quarter with approximately a $134 million in cash and equivalents compared with approximately $139 million at the end of fiscal 2019. Cash flow from operations for the first nine months of fiscal – of the year was $7.7 million, compared with $15.1 million for the same period last year.Accounts receivable was $39.7 million, at October 31 versus $46.4 million a year-ago, mainly due to lower services and maintenance billings. Days sales outstanding using the countback method was 45 days for fiscal 2020 third quarter, compared with 48 days for the same period last year.Our short-term deferred revenue balance at October 31 was $81.9 million versus $80.5 million a year-ago, including $32.8 million of deferred subscription versus $27.8 million, $47.1 million of deferred maintenance versus $50.7 million, $1.7 million of deferred professional fees versus $1.8 million and $200,000 of deferred license and other versus $200,000.As a reminder, our maintenance contracts are billed annually, while subscription contracts can be built either annually or quarterly. I will finish up my remarks with the full-year fiscal 2020 guidance, reflecting lower professional services in the second half of the year, lower licenses in Q4 and currency effect.Revenue of approximately $311 million, including subscription revenue of approximately $108 million, GAAP pretax loss of approximately $4 million, and non-GAAP pretax income of approximately $8 million.With that, I'll turn it back to you, Anton.

[Anton Chilton:]

Thank you, Daniel. So as discussed earlier, it was very pleasing to see the volume of cloud deals up to a record number, and in particular, the continued momentum in winning new customers, affirming our competitive strengths in ERP cloud for global manufacturers. We closed 25 cloud deals with 14 coming from those new customers and 11 from conversions.As I mentioned on our last call, our newly launched Adaptive ERP and low-code/no-code Enterprise Platform provides significant opportunity to keep that competitive momentum going. That said, while the skew and deal numbers this quarter tended towards new customers on a year-to-date basis, we still see a 50/50 deal value mix between conversions and new customers, and our sales pipeline reflects that mix.We continue to experience less short-term demand for large professional services projects, with the majority of converting customers elect to move and enjoy the benefits of the QAD cloud in advance of completing upgrade projects. But our heavy emphasis on managing costs in professional services and placing a stronger focus on expanding partner utilization on a global basis has allowed us to materially improve margins in that sector of the business.Our continuous efforts to drive efficiency through automation and process improvements in our cloud business have seen cloud margins also improve over the period.Looking at the quarter geographically, North America continued to perform well. Following the end of the quarter, we're also very pleased to welcome Michael Brunnick, who has joined us as our new Senior Vice President for North America. Michael comes to QAD with many years of enterprise software sales experience in companies such as Luminoso Technologies, Socialware, HP Software, Open Text and Vignette. We expect Michael will build on the success that Ed Boclair, our Senior Vice President of Global Sales achieved in North America prior to his global appointment.EMEA had a solid quarter and continue to build the pipeline for the remainder of this year and the next. We are continuing to complete our sales team in the region with only a few slots remaining open. And while discussing EMEA, I'm currently speaking to you from our office in Barcelona.I spent the last few weeks here in Europe attending a number of customer and partner focused events. Customers have responded exceptionally well to our positioning of QAD Adaptive ERP as an enabler for rapid change and also to the application of our industrial Internet of Things backbone, where we connect manufacturing operations on the shop floor for the ERP in real-time. Asia Pacific and Latin America showed a bit of weakness, mainly around our China business, where the trade war seem to be having some impact on their economy.Three of our verticals, electronics, industrial, consumer packaging, food and beverage and life sciences performed quite well in terms of cloud bookings in the quarter. Automotive was a bit lower after having an absolute banner second quarter and remains strong on a year-to-date basis.Our employee count came down a bit to north of 1,900 full-time employees, mainly due to the adjustments we made in our professional services organization. Our total direct salespeople stands are now about 90. We are still looking to hire a few more in specific areas and are pleased with the caliber of talent we've been able to attract.On the solution side of the business, we recently held a hackathon in Poland, hosting teams from over 25 of our EMEA partners to develop new business applications in our low-code/no-code Enterprise Platform, which is 24-hour development time. We saw some outstanding results with some functionally-rich apps developed in just that short time span.In the QAD Labs, we continue to invest R&D resources in digital transformation and indeed our latest version of demand and supply chain planning now shifts with embedded artificial intelligence and machine learning, helping customers’ further increase demand forecast accuracy.I'll now hand the call over to Pam for a bit more color on those cloud deals.

[Pamela Lopker:]

Thanks Anton. As we said, in Q3, we had 25 new bookings. There were 11 conversions and 14 net new deals. We saw orders from all regions and all verticals with North America having exceptional cloud quarter and our CP, food and beverage vertical [indiscernible] delay in bookings and revenue – booking revenue.This quarter we had a food and beverage win against SAP and Oracle. The company was using an older version of JDE, which, of course, is now owned by Oracle, and they were in the midst of considering a very expensive multiyear move to either SAP or Oracle.Towards the end of their evaluation, the company purchased a food and beverage company using QAD and decided to take a look. At the end of the review, they determined QAD should meet their needs in a much shorter time and the platform technology would eliminate most, if not all, their customizations. So this quarter, we received an order for the first of potentially many more sites from this company.Last quarter, I mentioned Europe had a large competitive win against SAP a large automotive supplier. I am happy to say that this customer is already live and referenceable. From contract to live in less than three months, really exciting and a very pleased customer.Again this quarter, we had several small life science wins. I love looking at the technology coming out of these startups. And I'd like to point out a few of the amazing capabilities. So if you look at these customer bases here, this quarter, we will have solutions where kids will soon be able to get their ear tube in doctors’ offices without surgery.For people of all ages, there will be a way to repair and actually re-grow disease entered or defective tissues and organs. For patients on dialysis, soon they will be able to have dialysis treatment in the comfort of their own home. For chronically ill patients, the next-generation of medical devices will have smart sensors and artificial intelligence applied to clinical data to improve diagnostics, strategic interventions, entry prevention and better overall patient care. Really exciting capability in those areas.We won these accounts from a longer list of competitors, but mainly NetSuite, SAP and Infor. Our customers told us they selected QAD due to our life science experience, support for regulatory compliance in the cloud and easy-to-use solutions. Our ability to deliver Adaptive ERP cloud solutions for our global manufacturing customers, enabling agile business processes at an unprecedented level of speed is providing exciting capabilities to both existing and new customers.Thanks Anton. Back to you.

[Anton Chilton:]

Thank you, Pam. So looking forward, our investments in sales and marketing continue to drive lead flow volumes, which remain ahead of our internal targets and our cloud pipeline continues to grow, and currently is up over 25% from the same period last year.As reinforced by feedback from our customer conferences in EMEA this month, manufacturers need for rapid response to change continues to increase. QAD Adaptive applications give our customers and prospects, cloud solutions, providing them the ability to adapt in real-time. Our total addressable market for cloud solutions continues to grow and our market position is improving.Short-term risks do still remain a factor including uncertainty facing manufacturers around tariff negotiations and global geopolitics. PMIs globally have continued a slow decline and may play a part in future deal cycles.As stated in prior calls, so far, we haven't seen a material effect on our pipeline and we don't expect it to affect our longer-term goal. In summary, we continue to win business from competitors and we are aggressively driving our cloud business with substantial market opportunity in front of us. We remain exceptionally well-positioned to meet our long-term objectives.Operator, we're ready to take questions from analysts.

[Operator:]

All right. Thank you. [Operator Instructions] And we have a question from Bhavan Suri from William Blair. Please go ahead.

[Bhavan Suri:]

Hey everybody. Thanks for taking my questions and congrats on continued success there. I wanted to touch on the continued trends of cloud customers sort of on the existing base. There's a long runway there for conversions from existing base. You’ve sort of mentioned it bounces back and forth between new, but I guess the big question I have is, have you seen any change, have you seen an increase maybe in the interest around cloud adoption, the base is still pretty steady eddy?At some point, I think you know obviously we see that sort of inflection happening as people understand the value of the cloud. Just sort of seeing – what you're seeing from trends in terms of the conversations, the adoption, the acceptance, the interest. Would love to get a little more color there.

[Anton Chilton:]

Sure. Thanks, Bhavan. Absolutely. So as we said, we expect that the deal mix to stay at that kind of 50/50 by value. That said, obviously, we continue to grow the business. And so I would say as part of that, there is a growing groundswell, if you like, momentum in the existing base and that shift towards cloud and that helps us maintain that 50/50 kind of mix. So we're seeing both an increase in new business as well as an increase in interest from customers on the conversion side. And when you put those two things together, that's helping us grow our business overall.

[Bhavan Suri:]

Yes. And you increase that in the pipeline and the billings number there. I guess, you obviously mentioned China as an impact, but love to understand about the customer adoption funnel build up with Alibaba. Is that too early yet? And if it is, when do you expect it to be sort of a meaningful contributor? Could this offset some of the tariff issues? Or those two things sort of tied together? Love to get some color on the relationship and how it's progressing and then obviously the offset to the tariffs issue?

[Anton Chilton:]

Yes. Look relationship, we're very, very happy with. We have our first customer live in the cloud there and that's been very, very successful. We're right at the final stages with another existing customer that’s looking to move six of their China sites. There are large enterprise customer global, but they're going to looking to move their six Chinese manufacturing operations into the Alibaba cloud in the near-term.I would say just a general sentiment in China right now, and there has been an impact on the economy. So things are moving a little bit slower than we would have liked than anticipated originally. But we still are very confident that in the medium-term, this is a great relationship for us and it's going to drive increased cloud momentum in that China business, but a little bit slower than we had originally anticipated.

[Pamela Lopker:]

We do – if I could add to that, we did have cloud partnerships in Asia Pacific, not in China. And we did see resistance from the Chinese companies as well as sites in China to move to a datacenter that was actually in Singapore. So by having this relationship with Alibaba in China, I think that may help neutralize that or at least that's what the customers are saying to us that they want to make sure that their data is actually in China, and the Alibaba deal is a good one.

[Anton Chilton:]

Yes.

[Operator:]

All right. Thank you. And now to line of Brad Reback from Stifel. Please go ahead.

[Brad Reback:]

Great. Thanks very much. Anton, any update on how we should think about the subscription growth rate for next year? I think last quarter you talked about exiting the 30% growth rate. It seems between FX and maybe some of the macro that might be off the table. But any color would be helpful. Thanks.

[Anton Chilton:]

Yes, absolutely. So Daniel has put the guidance stuff together. So I'll maybe ask him to just give you a bit more of that detail.

[Daniel Lender:]

Yes. So we haven't issued guidance for next year, Brad. But so far, we believe we are actually in track to return to 30% given the bookings that traction that we've gotten this year, and we're expecting in Q4. So we do expect to be coming back towards the 30% level next year.

[Brad Reback:]

Great, thanks. And Daniel, on the cloud gross margin, you guys have clearly done an excellent job driving that higher. How should we think about additional gains from the mid-60s here?

[Daniel Lender:]

Yes. So we're still aiming to improve it by 1% to 2% on a yearly basis, Brad. We're still in early stages with regards to our Channel Islands. So we're still working through some of the technology requirements that are needed to run all of the additional capabilities that Channel Islands brings. But I do expect that when we issue guidance next year, we'll issues some more firm longer-term goals with regards to our overall margins there.

[Brad Reback:]

Great. Thanks very much.

[Anton Chilton:]

Sure.

[Operator:]

Thank you. And now to the line of Zach Cummins from B. Riley. Please go ahead.

[Zachary Cummins:]

Yes. Hi, thanks for taking my questions. Just a few incremental for me. I mean in terms of the guidance that's implied for Q4, can you talk about the drivers for a little bit of the acceleration we're expecting to see for subscription growth in Q4 of this year?

[Anton Chilton:]

Daniel, do you want to go over the guidance numbers there?

[Daniel Lender:]

Yes. I think if I understand your question – if we understand your question correctly, Zach, you're talking more about – are you talking more about the business drivers behind the subscription growth?

[Zachary Cummins:]

Yes. That and in terms of – it seems like it's going to, at least on a reported basis, it's going to be getting to closer to 20%-plus growth versus kind of that mid-teens level that we had here in Q3.

[Daniel Lender:]

Yes. So I mean from a – as I mentioned when I was answering Brad's question relating to next year, we've done, I think, a very good job this year in improving our overall bookings from where we were last year. So we've showed a significant improvement, and that's throughout the year has been translating into that additional subscription revenue, and we do have quite a strong pipeline for Q4. Q4 tends to be a stronger quarter from a seasonality standpoint for us. And so that will clearly have an impact in both in terms of the revenue for Q4 as well as our revenues next year.

[Zachary Cummins:]

Got it. That's helpful. And Anton, can you talk about your approach to professional services going forward? I know you've rationalized a little bit of that organization and started to offload some more to third-party partners, but how should we think about the professional services line and your approach to that as we continue to move forward here?

[Anton Chilton:]

Yes, absolutely. I think as I talked about on the last call, we've had, at that time longer-term plans to grow professional services at a much slower rate than we grow the rest of the business particularly around cloud and start to integrate more with or expand our partner network around that and using them in a much more integrated fashion.And we've accelerated that plan now. So we've done some of the rightsizing to get the cost under control, drive those margins back up as we've done. We think we're at a good level now that gives us a good foundation on which to then increase our use of partners, still have critical mass within the QAD services organization that allows us to bring all of the good stuff around program management capability. And then, as I said, over the medium-term, it will grow that business, but at a much lower rate than the rest of the business, particularly the cloud growth.

[Zachary Cummins:]

Got it. That's helpful. Well, thanks again for taking my questions and best of luck towards the end of the year.

[Anton Chilton:]

Thank you.

[Daniel Lender:]

Thank you, Zach.

[Operator:]

Thank you. And now to the line of Kevin Liu from K. Liu & Company. Please go ahead.

[Kevin Liu:]

Hi, good afternoon. Maybe just kind of following on to the services question. Certainly you are bringing in more partners to help out on the implementation side, could you talk to what extent you're also seeing more leads or additions to the funnel coming in from partners?

[Daniel Lender:]

So yes, we've been focused primarily on – right now in terms of expanding services partner network. We will be bringing in somebody that's going to be helping us expand, let’s say, the sales channels through partners. And so our intention there is to – particularly with the launch of Adaptive ERP and the Enterprise Platform, we think there's going to be an attraction there for both our existing partners to extend their businesses and also for new partners to come in.So I'd say that's – the primary focus right now has been on partners to supplement our services capability and capacity. Moving forward, we will be adding to that an incremental focus on getting more and more channel partners there and increasing that part of the business too.

[Kevin Liu:]

Got it. And then just looking at kind of the implied guidance for the fourth quarter here, certainly subscription continues to decline, but that also implies licenses might actually come down sequentially with Q4 typically being a strong quarter kind of for overall bookings and license growth, maybe talked about some of the drivers there? Is it predominantly just seeing more adoption of the cloud side within your pipeline or do you anticipate some sort of macro weakness on the deal cycles there?

[Anton Chilton:]

So as Daniel [flagged] there, our pipeline is looking good for Q4. And so we're not seeing the effect of macro at this point. Of course, those things can change, but right now we're feeling confident about the size of the pipeline we've got compared to the targets that we have and looking forward to a strong performance there from a cloud perspective for sure.

[Daniel Lender:]

Yes. With regards to licenses, Kevin, our sales force has been zeroed in on bringing in cloud deals. And this year really we're not seeing – the funnel is now really heavily weighted towards cloud. There's very, very few license deals left out there. So we're not expecting a seasonally higher license number that we've seen other years, and that we had – when we started the year, we were kind of planning on that potential. So it's really not – I mean there is some effect on licenses from the overall manufacturing, lack of growth in manufacturing because any licenses that we get is additional users, by the fact that the sales force is entirely focused on cloud, we're not seeing anything else out there that would make that number go higher.

[Kevin Liu:]

That's helpful. And then just lastly, obviously, this year has been big in terms of hiring on the sales side. Can you talk about how you're feeling about the productivity ramps of the reps you've added over the course of this year and how you're feeling about your sales capacity going into next year?

[Anton Chilton:]

Yes. I think we're on track in terms of what we plan to hire. As I said on the call, very pleased with the caliber of the people that we brought into the organization. We do typically plan for somebody to take around six to nine months to come up to speed to, let's say, full sales productivity.But pleasingly as we've seen some of the people that we got in early this year already contributing to those cloud bookings performance, so I'm happy with that. We've got a few slots left to fill, but not many. And we think that puts us in a really good and strong position heading into next year to continue that momentum.

[Kevin Liu:]

All right. That's great to hear. Congrats and thanks for taking my questions.

[Anton Chilton:]

Thank you.

[Operator:]

Thank you. And now to line of Ishfaque Faruk from Sidoti & Company. Please go ahead, sir.

[Ishfaque Faruk:]

Hi. Good afternoon, guys. A question regarding guidance. The guidance for Q4 sort of implies a slight decline from the guidance you guys laid out for Q2. And you guys – Daniel, you mentioned briefly that some of that has to do with licenses. Is the rest of the delta primarily to do with professional services or maintenance? How should we think about it going forward?

[Daniel Lender:]

Yes. So our professional services revenue is lower, in general. It was a bit lower than we were expecting even in Q3 and we're expecting about the same run rate in Q4. Having said that, we've really managed the profitability of that business and adjusted to the revenue line. So on a bottom line basis, actually, there's no effect there.And then there’s the currency effect that I talked about earlier, with this quarter there was about $200,000. On subscription, overall, it was about $700,000 from last quarter. So given where currencies are today that's having an impact to the overall year as well.

[Ishfaque Faruk:]

Okay. And on the cloud, you guys had very strong cloud booking and margins have been up significantly as well. And Daniel the cloud outlook that you mentioned that you expect subscription to go back up to 30% growth for the coming year or so, is that mostly predicated on the recent cloud bookings that you guys had?

[Daniel Lender:]

Yes. I mean our expectations – some of it has to do with the cloud bookings that we've done – we did. We've done through the first three quarters of the year. And then the remainder is based on our expectations for Q4. And the first couple of quarters of next year, that's really – those are really going to be the key drivers for growth next year.

[Ishfaque Faruk:]

Okay. And my last question, on the Alibaba relationship, you guys mentioned that you guys have, like, a client up and running. What are you guys seeing in terms of your initial conversations with some of the China-based companies moving forward, et cetera, now that they feel more secure with China-based data centers?

[Anton Chilton:]

Yes. Back to the point Pam was making earlier. We had a very positive reaction. And I think that comes in two areas, right. So one is having the capability locally in China and so they feel much more secure about having their data in China.And then secondly, of course, the power of the Alibaba brand is very well known and very well respected over there. And so when you put those two things together with the QAD cloud ERP, I think it's a very compelling message. So I think that's stimulating a lot of interest.Interestingly, the Chinese government is also compelling or at least encouraging organizations to start to use more and more cloud services. And so I think that will help us drive that momentum forward too into the medium-term.

[Ishfaque Faruk:]

Wonderful. Thank you, guys for taking my questions.

[Daniel Lender:]

Thanks, Ishfaque.

[Anton Chilton:]

Thank you.

[Operator:]

Thank you. I'd now like to turn the call back over to our host, Anton Chilton for closing remarks. Please go ahead, sir.

[Anton Chilton:]

Okay. Well, if there's no more questions, we thank you and we look forward to announcing our quarter four results in a few months time. Thank you very much.

[Pamela Lopker:]

Thanks everybody.

[Operator:]

Thank you. And ladies and gentlemen, this call will be available for replay after 4