QAD Inc.
Q1 2019 Earnings Call Transcript

Published: 31 May 2018

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the QAD fiscal 2019 first quarter financial results. At this time, all lines 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, today's conference is being recorded. I'd now like to turn the conference over to Chief Accounting Officer, Kara Bellamy. Please go ahead.

[Kara Bellamy:]

Hello, everybody. Welcome to this afternoon's call. Before we begin, I need 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 subjects to risks and uncertainties that could 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 Karl Lopker, QAD's Chief Executive Officer.

[Karl Lopker:]

Well, good afternoon. And thank you for joining us to discuss our first quarter results. Daniel Lender, Chief Financial Officer, and Pam Lopker, President, are joining me on the call. Our results for the quarter exceeded our guidance, both on revenue and profit. Strong performance across all revenue categories and the effect of the transition to the new accounting standards all contributed to these results. We also held our annual Explore user conference where we received very positive feedback from our customers on our new technologies. Our cloud bookings came in as expected, a bit lighter on overall value after a very strong fourth quarter, but there was still significant activity. We added 13 new cloud customers in the quarter, and 5 conversions from on-premises. Our precision division was particularly strong, bringing in two important new cloud customers in very competitive deals. Daniel, can you continue? It looks like I'm losing my voice.

[Daniel Lender:]

Sure. No problem, Karl. As we planned, our services business turned profitable in the quarter and we do expect it to remain profitable for the year. Our focus for services has been, and continues to be, to meet our customers' requirements for new implementations and conversions to the cloud. Our sales funnel is up over 10% from last year and cloud is now approaching 70% of our funnel, up from 60% last year. On a regional basis for the quarter, all regions performed well similar to previous years. Full-time employee headcount at 1,865 was up 5% from last year. The increase was mainly in development and sales. The manufacturing economy continues to roll along nicely and we expect to continue to keep up the pace in cloud that we experienced last year. That is, of course, unless the proposed trade tariffs cause a hiccup. Let me turn the call over to Pam for a closer look at our cloud activity and our Explore conference. Pam?

[Pamela Lopker:]

Thanks, Daniel. And thanks, Karl, too. Sorry about your voice. Q1 was another good-looking quarter, particularly for new customers. In Q1, we had 18 cloud deals, of which 13 were new cloud customers and 5 conversions, representing all verticals and all regions. This quarter, the North American region and the electronics and industrial vertical had the largest dollar bookings. I'd like to highlight life sciences' quarter is actually particularly exciting to me, the innovation going on in our life science customers. While most of the deals are relatively small in booking value, the potential for these customers is important. This quarter, we had five new life science customers making all sorts of innovative products, including surgical robots, regenerative tissue technology, and drug delivery through robotic pills. Very exciting. These companies joined the large number of life science companies using QAD cloud. Our cloud offering is compelling for life science companies as we provide a qualified platform that enables an efficient audit by the FDA and other regulatory agencies. Our offering also provides them with industry-specific functionality such as providing the traceability and compliance capability to successfully run their life science businesses. Karl mentioned a couple of important new cloud customers for our precision division. I'd like to highlight one of them. A company that makes GPS receivers and other navigation systems. The company replaced an existing solution from one of precision's large competitors. Leveraging precision's innovative solutions for shipping and trade logistics, the company will deploy transportation execution, global trade management, trade compliance, and delivery exception management to support distribution centers in both the US and Europe, and they will use trade compliance for screening vendors, partners, and customers. I'd also like to mention our Explore conference that was held in Dallas, Texas earlier this month. A central focus of the conference was the exponential pace of change manufacturers are facing both in their markets they serve as well as how they manufacture. At Explore, we announced the general availability of our Channel Islands program for cloud customers for September 2018. Channel Islands is our next-generation, flexible ERP system built on the QAD enterprise platform. It provides our customers with a rapid response for change allowing for a great fit for today and tomorrow. It also supports advanced technology under the banner of Industry 4.0 to be easily adopted by customers and uplifted as these advanced technologies evolve. The response is overwhelmingly positive with 98% of the attendees saying they would suggest their companies to attend in the future. Daniel, back to you.

[Daniel Lender:]

Thanks, Pam. Our first quarter revenue was above our guidance of $80 million, with total revenue growing 21% from the prior year to $86.2 million. We adopted the new revenue recognition accounting standard in the quarter, which resulted in additional revenue of $3.2 million, of which about half was not in our forecast. All revenue categories performed well. Subscription revenue of $21.5 million exceeded our forecast, growing 40% from last year. Subscription revenue now accounts for a quarter of our business. Subscription margins grew to 62%, up from 50% a year ago as we continue to benefit from economies of scale and operational efficiencies. We remain on target to achieve annual subscription margins of 60% in fiscal 2019. However, as we make additional investments in our data centers and cloud operations, quarterly margin fluctuations should be expected. Maintenance and other revenue was $31.5 million. On a performance basis, maintenance and other revenue was down 6% from the prior year, primarily due to customer conversions to the cloud and our historical attrition rates. Maintenance revenue is expected to continue to decline as existing customers convert to the cloud. Recurring revenue, which equals subscription plus maintenance revenue, grew 12% from prior year and was 61% of total revenue for the quarter compared to 66% a year ago. The decline as a percent of total revenue is due to the large increase in professional services, which grew by 43% compared to last year's first quarter. License revenue was $6.3 million versus $5.3 million last year. We closed three deals greater than $200,000 and one deal greater than $1 million. As a result of the current, strong global manufacturing environment, we are continuing to generate license revenue from existing QAD customers as they add new users on modules. In this quarter, however, we signed a large deal with a new automotive customer in the US, with the majority of the deal as an on-premises solution. This was a highly competitive deal, and the customer would only consider an on-premises solution at this time. Professional services revenue was up 43% to $26.9 million from $18.9 million last year. $1.8 million of the increase was related to the recent adoption of ASC 606. This amount was not forecasted. Services margins were 10% for the quarter, but would have been 3% not including the effect of the new accounting standard. New cloud implementations and existing customer upgrade projects continued to generate demand for our professional services. In addition to our normal professional services, we have also been providing some personnel augmentation services to one of our cloud customers, mainly through subcontractors at minimal margins. We do expect professional services revenue to taper down mainly related to augmentation services. For the remainder of the year, we continue to believe that we will be able to generate a small profit in services. Currency fluctuations did not have a significant impact to our results versus our guidance. However, compared to prior year, currency had a positive impact on revenue of $3.4 million, including a $500,000 positive impact to subscription, $1.7 million positive impact to maintenance, and $300,000 positive impact to licenses, and a $1 million positive impact to professional services. This was offset by negative impact to expenses of $2.8 million. Overall, compared to prior year, currency had a $600,000 positive impact to net income, but negligible impact compared to forecast. Total revenue by vertical for the first quarter was automotive at 43%; high-tech and industrial, 29%; consumer products and food and beverage, 16%; and life sciences, 12%. And by geography, total revenue was North America, 46%; EMEA, 29%; Asia-Pacific, 15%; and Latin America, 10%. Our gross margin was $45.1 million or 52% of total revenue compared with $36.5 million or 51% of total revenue from last year's first quarter. Sales and marketing expense totaled $19.9 million or 23% of total revenue compared with $17.6 million or 25% of total revenue a year ago. On a performance basis, sales and marketing increased $1.6 million, mainly due to higher personnel expense, resulting from additional headcount. This year, we made some changes to our sales force that resulted in a reduction of the commission salespeople and the creation of an inside sales organization. While this resulted in a reduction of commission sales people, the combined group increased in size by about 10%. R&D expense was $14 million for the 2019 first quarter versus $11.5 million last year. On a performance basis, R&D increased $2 million, primarily due to higher personnel and third-party contractor expense, driven by additional investment to support our Channel Islands initiative. R&D expense was 16% of total revenue for both periods. General and administrative expenses were $9.4 million or 11% of total revenues compared with $8.6 million or 12% of total revenue last year. On a performance basis, G&A increased $500,000 related to higher accounting and tax professional fees as well as payroll taxes due to stock plan activity. This brings total operating expenses to $43.3 million or 50% of total revenue compared with $37.9 million or 53% of total revenue last year. Stock compensation expense was $2.1 million for fiscal 2019 first quarter and $1.8 million last year. Operating income was $1.8 million versus an operating loss of $1.4 million last year. Our GAAP pretax income was $2.6 million versus a GAAP pretax loss of $2 million for last year's first quarter. Our non-GAAP pretax income totaled $4.6 million versus $146,000 a year ago. Income tax expense equaled $1.2 million for fiscal first quarter versus $600,000 in the prior-year. Similar to last year, we expect the results to be close to breakeven for the year. So, we are recording taxes each quarter based on actual quarterly results. Tax expense includes the impact of the new tax reform regulations. Although due to QAD's existing tax credits, we do not expect the new regulations will have a material effect on our cash taxes or tax expense this year. We ended the quarter with $144 million in cash and equivalents compared with $147 million at the end of fiscal 2018. Our accounts receivable was $56.9 million compared with $83.5 million at the end of fiscal 2018 and $46.4 million a year ago. Our days sales outstanding using the count back method was 56 days for the fiscal 2019 first quarter versus 55 days for the same period of last year. And the quality of our receivables remain healthy. Our short-term deferred revenue balance at April 30 was $103.4 million versus $97.2 million a year ago, and it includes $72.1 million of deferred maintenance versus $70.7 million, $28.5 million of deferred subscription versus $23.3 million, $2.3 million of deferred professional fees versus $1.7 million, and $21,000 of deferred licenses versus $900,000. As a reminder, maintenance contracts are built annually and subscription contracts can be built either annually or quarterly. Our cash flow from operations was $3.8 million for the first quarter of fiscal 2019 compared with $7.9 million last year, primarily as a result of higher payments for bonuses and commissions due to strong cloud bookings and revenue growth in the prior-year. Now, moving on to our guidance. For fiscal 2019 second quarter, we're expecting total revenue of approximately $82 million to $80 million, including $21.8 million to $22.3 million of subscription revenue, GAAP pretax loss of $1.5 million to $2 million and non-GAAP pretax income of $1.3 million to $2 million. Our fiscal 2019 second quarter guidance includes $3.3 million of stock compensation expense. We normally issue our annual grants; and our board grants vest during the second quarter. We are maintaining our full-year guidance and continue to expect total revenue of $328 million to $332 million, including $90 million to $92 million of subscription revenue, our GAAP pretax income of breakeven to $3 million and non-GAAP pretax income of $11 million to $15 million. And as usual, we will now take questions live. Operator, can you please give instructions for questions.

[Operator:]

[Operator Instructions]. Our first question comes from the line of Brad Reback with Stifel. Please go ahead.

[Brad Reback:]

Great. Thanks very much. Maybe going back to the cloud conversions, have you guys seen any change in the economics versus a few years ago on the uplift with these, I'll call them, later adopters? Thanks.

[Pamela Lopker:]

Shall I take that, Daniel? Or do you want to…?

[Daniel Lender:]

Yes. Let me take the first part of the question, Pam, and then I'll let you cover the next. I think from– from our conversions, Brad, in terms of the lift that we see from maintenance to cloud, we're still seeing about a three times conversion rate. So, from that standpoint, not a significant change. Sometimes it's a bit lower, sometimes higher, but it's still averaging around a 3X number. And, Pam, I don't know if you want to make any comments regarding our customers.

[Pamela Lopker:]

Yeah. I think that that's true. I think the larger customers, it's somewhat easy because they understand the cost that they spend already. The smaller customers, they'll have an engineering guy, they'll have some finance person handling the system, so they can't divide it out. They don't feel like they're going to save personnel time. So, I think it's holding. It's always a struggle with a particular customer. It's like if they want to go to a cloud, it works. If they don't want to go to cloud, then they're looking, oh, well, no, I'll pay for cloud what I pay for maintenance, and that's never going to work for us.

[Brad Reback:]

Great. Thanks very much.

[Daniel Lender:]

Thanks, Brad.

[Operator:]

[Operator Instructions]. Our next question comes from the line of Matthew Galinko. Please go ahead.

[Matthew Galinko:]

Hey, thanks. Thank you for taking my question. You mentioned on the auto deal that went to premise that was a fairly highly – tightly-contested deal. Can you talk about what got you the win there?

[Daniel Lender:]

Yeah, sure. So, this was a US-based company, as we mentioned, Matt and we were competing against SAP and IQMS. And they basically – it was a company that really has not changed their ERP in almost 20 years, long sales cycle of almost a year. So, significant amount of research by them went into it. And they wanted to ensure that they got a partner that was able to give them all the functionality that they needed from an automotive solution as well as being able to have somebody that they could rely in having a successful implementation. So, I think our reputation both in automotive, our capabilities in that industry, and our reputation of being able to have successful, fast implementations were key to that win. Pam, I don't know if there's anything else you want to add to that.

[Pamela Lopker:]

Yeah. I think they are a very, very conservative company. We get a lot of demos, a lot of references. It took a long time, as Daniel mentioned, to make that decision. So, a very conservative company and we wanted to make the right choice for a long time.

[Matthew Galinko:]

Got you. And then, I guess, can you fill in a little bit more about – if this is going to be a 20-year kind of implementation? Insofar as you could talk about it, why was the customer so focused on a premise solution given where the industry or software consumption seems to be going, if you will?

[Pamela Lopker:]

This is a private company. So, it's not a public company. And I think they just are very, very private. Daniel, do you want to add to that?

[Daniel Lender:]

Yeah. I think it's just the fact that they are very conservative, obviously. They take really a long time to change. It doesn't mean that the company will not be able to potentially convert to our cloud solution in the future. And again, this is one reason – or one of the reasons why we still will compete on an on-premises deal because we have the ability to then convert our on-premises customers over to the cloud.

[Matthew Galinko:]

Got you. Appreciate that. And then, maybe on the life sciences wins, you highlighted – I think you used the phrasing that's sort of low dollar value, but a lot of potential there. Can you maybe flesh out a little bit sort of just customer wins or you think you'll capture other logos, and that's where the potential comes from or do you see growth within those existing wins?

[Daniel Lender:]

So, on the life sciences side, you tend to see a lot of – a greater number of companies that have a significant amount of requirements given their industry, but they don't necessarily have the size of some of their larger enterprises. So, on the life sciences side, in particular, we tend to get more companies that are of smaller size. So, those deals tend to start smaller; as the companies grow, then they have that potential of becoming bigger. Outside of life sciences, we do get a number of situations where companies will roll us out across their entire enterprise over time. So, as our overall cloud customer base has continued to increase, we do see additional potential and additional revenue that comes in from these existing companies.

[Matthew Galinko:]

Got you. And, sorry, one more for me, just on 606. I think what I understood from your commentary was that there was about $3 million of revenue that came in that you weren't expecting as a result of 606, is that correct? And was that where the professional services came from predominantly?

[Daniel Lender:]

Yeah, that's correct. The bulk of that, about $1.8 million, came from – was unexpected. And the bulk of it was from professional services. So, not all of $3 million was unexpected. About $1.8 million was unexpected.

[Matthew Galinko:]

Got you. all right. I appreciate the color.

[Daniel Lender:]

Sure, thanks.

[Operator:]

Our next question comes from the line of Bhavan Suri with William Blair. Please go ahead.

[Bhavan Suri:]

Hey, guys. Can you hear me okay?

[Daniel Lender:]

Yes.

[Pamela Lopker:]

No problems, Bhavan.

[Bhavan Suri:]

Great. Thank you. And thanks for taking my questions. I guess, I will touch a little bit on that services piece really quickly and then jump over to a couple of other questions in a second. But when I look at the services piece, you've, obviously, talked about ramping services for the backlog in cloud. I'm trying to understand – obviously, there's sort of the one-time pieces, but services was still pretty healthy. I guess, should we think of that as a leading indicator for subscription, like you have to implement it before you charge subscription vis-à-vis sort of someone buys on-premise and then they implement it, but they're still paying for the on-premise license upfront. Does the sort of the dynamics of the cloud business mean that I see subscription as more of a leading indicator – sorry, services a leading indicator of subscription? Is that the way to think about it?

[Daniel Lender:]

Yeah. So, some of the services business would fall under that category, but not all of it because there's different types of projects. We have projects that are implementations. And in the case of implementations, as we are doing a particular rollout, for example, on a cloud customer, yes, some of that would be a leading for additional services business going forward. There are a number of customers that – a number of services projects that are doing upgrades for existing customers. So, those won't necessarily tie to that. And as I mentioned during my remarks, we're also providing to a particular – to one customer, what we're calling, personnel augmentation services at very minimal margins. So, that is really unrelated to our normal type of business.

[Bhavan Suri:]

Got it, got it. That helps. Thank you, Daniel. And then, maybe one for Pam here. Pam, just an update on the division products. We, obviously, hear a lot about the business, but just if I look at CEBOS, Precision, DynaSys, sort of how are those doing? How is the cloud adoption of those modules divisions doing? And then, I guess, are you seeing those divisions, especially some of them, help you expand beyond the core six verticals? And is that sort of a future opportunity for the core ERP piece or do you sort of think that that's still limited?

[Pamela Lopker:]

Well, I'd say in the precision sector, they do sell outside of our verticals. They've actually sold a lot of banks and a handful of universities. And so, I don't think that those are particularly verticals we would go after, but because of the nature of their business, they do do business outside of our vertical. And they're all doing quite well in the cloud. I want to say that each one of them now are thinking that cloud is it going forward, which has been a transition for some of them, thinking, oh, no, people won't buy this in the cloud.

[Bhavan Suri:]

Got you. Got you. And then, one last one from me. At the conference, you focused a lot on advanced technologies. And you've sort of seen the investments in Channel Islands start to play out and you look at sort of R&D spend, as you sort of think about the value in AI and machine learning and manufacturing, are you seeing use cases where you can leverage it? Are you guys thinking about modules of products out there? Just some color on what you're doing there. We saw sort of The Blockchain in Transport Alliance. So, just some sense of sort of what you see happening with some of these advanced features given that Channel Islands is kind of – some of the development efforts there are maturing, sort of what you might release in that space?

[Pamela Lopker:]

Sure. In general, we think machine learning is going to be invasive throughout our ERP system. Right now, the focus has been on forecasting, on being able to like get your automotive customers to adopt what's called broadcast, but they [indiscernible] way in advance and it's always wrong. Can we make that better? We've done a really good job so far, adding some machine learning capability to those broadcasts and making them more accurate, so that our customers can schedule to meet what they actually do or address the end instead of what they say they're ordering in the beginning. So, certainly, on the area of forecasting, this is really important. But I think all the planning parameters, all the planning capabilities are going to benefit from machine learning. So, that's going to be invasive inside of our software. And then, there's the connectivity to different types of machine learning, whether it is preventative maintenance – predictive preventative maintenance where we're going to just integrate with that and be able to raise a service order to fix a machine in advance of the pricing. And then what's very exciting from our customers is actually adding artificial intelligence, whether it's machine learning or more, to their products, so that when their customers have their products, they can start to predict when there's going to be a need for repair or for different components of the machine, consumables in advance of actually them needing them and being able to service them before they actually break or need something. So, we do see that type of thing as pervasive. The blockchain area is going to be very important in being able to track all the components of the final items, being able to track all the components, who made it, where it was, where it was sourced from, and be able to do things like when you have a warranty kind of claim, be able to have the smallest amount of recall. So, when you take somebody like Takata and the huge recall they had on their airbags, with the right amount of blockchain capability and digital twin, we would – there was the opportunity there to be able to have a recall in a fraction of size that was actually recalled, which actual airbags went into what actual cars that would have this issue that we need to recall instead of doing these broad-based recalls. So, I think there's a huge opportunity in our market and our customer base for all those items.

[Bhavan Suri:]

Great. That's very helpful. Thanks for taking my questions.

[Daniel Lender:]

Thanks, Bhavan.

[Operator:]

And we have no further questions in queue.

[Daniel Lender:]

Okay, very well. Well, thanks, everyone, for your attendance and questions. And we will update you again in August with our second quarter results. Goodbye.

[Pamela Lopker:]

Thanks, everybody. Bye-bye.

[Operator:]

Ladies and gentlemen, that does conclude today's conference. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.