QAD Inc.
Q2 2019 Earnings Call Transcript

Published: 22 Aug 2019

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the QAD Fiscal 2020 Second Quarter Financial Results Conference 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 our host Ms. Kara Bellamy. Please go ahead, ma’am.

[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 will 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 second quarter results. Joining me on the call are Pam Lopker, our President; and Daniel Lender, Chief Financial Officer.Our second quarter source hit guidance for subscription and overall revenues, but our results are down over the same period last year, largely due to lower services numbers. The quarter also delivered strong growth in cloud bookings and when combined with our Q1 achievement, beats our previous highest first half bookings results by over 50% in value.With some great competitive wins in the quarter, the record growth in bookings and our cloud sales funnel 37% ahead of the same period last year, we are seeing our sales and marketing investment starting to pay off.I’ll now turn it over to Daniel to discuss the financial results.

[Daniel Lender:]

Well, thank you, Anton. Second quarter results were essentially in line with our guidance with lower than expected services revenue. Subscription revenue came in at a high end of range at nearly $26 million and new cloud business closed in Q2 was on track with our target, but did not sufficiently exceed them to make up for the Q1 shortfall.For the second quarter, currency negatively impacted total revenue by $1.4 million compared with last year and by 400,000 for the fiscal ‘20 first quarter. Our bottomline was negatively impacted by 325,000 compared with the prior year and negligible compared with the first quarter.My discussion today about growth rates are given on a constant currency basis, unless otherwise noted. Second quarter revenue totaled $76.4 million, compared with $84.5 million last year, primarily resulting from declines in our Professional Services business and license sales.While we expected services revenue to decline, the decline was higher than anticipated, as existing customers are often to convert into the cloud without entering into significant upgrade project at the time of the conversion.As we’ve discussed previously, our license revenue is generated from existing customers, adding users or modules. This quarter as expected, license revenue declined due to continued conversion to the cloud, but was further impacted by the slowdown in manufacturing.Subscription revenue grew 17% and accounted for 34% of our business for the fiscal 2020 second quarter. Over the last 12 months, our subscription billings grew by 23%, with a three-year CAGR of 32%.Subscription margins for the quarter were fairly consistent at 62% versus 63%, a year ago. For the remainder of this fiscal year, we expect subscription margins to remain at current levels or to improve slightly, as we continue to make investments in support of our acceleration in cloud growth and the related infrastructure.During the quarter, we signed an agreement to partner with Alibaba to service our China market, the other public cloud solution. Our medium-term targets remain to increase subscription margins by 1 percentage point to 2 percentage points per year.Maintenance and other revenues were $29.6 million, compared with $30.6 million. On a performance basis, revenue was down 400,000 with the decline relating to conversions. Cloud conversions are expected to continue impacting our maintenance revenue line, but as a reminder, the conversion opportunity is generally three times maintenance, providing QAD with additional growth potential and a higher dollar margin on an ongoing basis.Professional Services revenue was $17.4 million, compared with $26 million for last year’s second quarter. Prior year revenue included a large multi-site global implementation project.Services margins were negative 4% for the second quarter, which was slight improvement over the first quarter. Despite our lower services revenue in the quarter and lower forecast for the remainder of the year, we’ve implemented a number of cost saving initiatives and continue to expect breakeven services margins for the full year.License revenue for the fiscal ‘20 second quarter was $3.5 million, compared with $5.6 million last year. In fiscal ‘20 period, there was one deal greater than 200,000 compared with seven last year.Total revenue by vertical for the second quarter was automotive 35%, high-tech and industrials 35%, consumer products and food and beverage 16%, and life sciences 14%.By geography, total revenue was North America 48%, EMEA 29%, Asia-Pacific 15%, and Latin America 8%.Our EMEA region is recovering nicely. We saw strong sales execution from them in the quarter and the future pipeline continues to improve. We have some additional sales down remaining, but there -- but we’re pleased to see some very positive momentum.Gross margin for the second quarter improved to 53% from 52% last year.Sales and marketing expense was $20.2 million or 26% of total revenue versus $19.5 million or 23% of total revenue for last year’s second quarter.Our marketing activities remain on track and we’re still planning on adding some headcounts throughout the remaining over the fiscal year.R&D expense was $13.9 million for fiscal 2020 second quarter, compared with $13.5 million a year ago. The increase related to our ongoing investments in Advanced Technology. As a percentage of total revenue, R&D expense was 18% this year and 16% last year.General and administrative expense was $10.4 million or 14% of total revenue, compared with $9.4 million or 11% of total revenue last year. The increase is mainly a result of moving our order processing employees from sales and marketing to G&A.Stock compensation expense totaled $3.2 million for the fiscal ‘20 second quarter and $3.4 million last year. This brings our GAAP pretax loss to $3.4 million, compared with GAAP pretax income of $2.6 million for last year second quarter. Non-GAAP pretax income was about breakeven versus $5.9 million last year.Income tax expense amounted to $9.9 million for the second quarter of fiscal 2020, compared with $1.5 million last year. The fiscal 2020 period included a one-time non-cash accounting adjustments of $10 million attributed to the placement of our valuation allowance mainly relating to the company’s Ireland deferred tax assets.Recent losses generated in connection with the company’s continued transition to and investment in a cloud model, require that a valuation allowance be placed in certain tax assets for accounting purposes.If you recall, we placed a similar valuation allowance on our U.S. deferred tax assets in the fourth quarter of fiscal ‘17. As cloud revenue continues to grow, we believe profitability will increase over the long-term and that our deferred tax assets will ultimately be realized.Due a large parts the valuation allowance replace this quarter on our deferred tax assets, our GAAP gap net loss was $13.3 million or $0.69 per Class A shares and $0.57 per Class B share. Last year GAAP net income was $1.1 million or $0.05 per diluted Class A shares and diluted Class B share.We ended July with approximately $142 million in cash and equivalents, compared with approximately $139 million at the end of fiscal ‘19. Our cash flow from operations was $14.2 million for the first half of fiscal ‘20, compared with $91 1 million last year.Accounts receivable was $41.5 million at July 31, compared with $54.3 million a year ago mainly due to lower services billings.Day sales outstanding using the count back method was 49 days for fiscal 22nd quarter versus 53 days for the same period last year.Our short-term deferred revenue balance at July 33 was $94.4 million versus $91.2 million a year ago, including $32.8 million of deferred subscription versus $27.8 million, $59.6 million of deferred maintenance versus $61.7 million, $1.8 million of deferred professional fees versus $1.6 million and $200,000 of deferred license and other versus $100,000. As a reminder, our maintenance contracts are built annually, while subscription contracts can be built annually or quarterly.I’ll conclude my remarks with our third quarter guidance. With our customers’ priority of converting to the cloud prior to upgrading their systems, we expect Professional Services revenue to be flat for the second half of the year compared with the first half.Additionally, the effect of the manufacturing economy slowdown on our licensed business, which is predominantly generated from existing customers adding additional capacity as they grow is reducing license revenue expectations for the remainder of the year, while subscription bookings are at record level both in number and value. The timing of the deal has had an impact to full year subscription revenue expectations. Therefore we are updating our guidance to reflect these changes.For the 2020 third quarter we’re anticipating revenue between $78 million and $79 million, including subscription revenue of $27.5 million to $28 million. GAAP pretax income was about breakeven to $1 million loss and non-GAAP pretax income of $2.2 million to $3.4 million.Our full year guidance now calls for revenue between $313 million to $318 million, including subscription revenue of $108 million to $109 million. GAAP pretax loss of $4 million to $5 million and non-GAAP pretax income of $6.7 million to $8.7 million.With that, I’d like to turn the call back to you Anton.

[Anton Chilton:]

Okay. Thanks, Daniel. As discussed earlier, we’ve seen our strongest ever first half cloud bookings performance and while our second quarter bookings exceeded our internal target, we didn’t fully close the revenue gap from Q1. However, our cloud funnel remains strong and continues to grow and is up 37% from the same time last year.We had 24 cloud deals in Q2, with 13 coming from new customers, balancing out the Q1 swing that we saw towards conversions. And as we stated in the past, we do continue to see about 50-50 deal mix between conversions and new customers on an annual basis.On our last call, we discussed the increase emphasis we are placing on winning new customers and taking market share. This paid off in some substantial deal wins against most of our major competitors this quarter. With our newly launched Adaptive ERP and low-code/no-code enterprise platform, we see significant opportunity to keep that competitive momentum going.With an accelerated take-up of fast-track migration to the cloud, we are seeing less short-term demand for large Professional Services projects. As a result, we have advanced our strategy of growing our partner community on a global basis, passing more of the services business into our ecosystem.Our direct services business will continue to grow over the long-term, but with a greater emphasis on the use of partners. We believe this strategy combines the benefits of QAD global project management, while giving our customers greater choice and flexibility.Looking at the quarter from a geographic perspective, it was very pleasing to see EMEA perform strongly, bringing in our largest cloud deal for the quarter and good win against our largest global competitor. We turn the corner in the region now from a sales performance perspective and our cloud funnel there is growing well.North America also had a good quarter from a cloud bookings perspective and subscription revenues were up, but licenses and services revenue was down over the same period last year. Latin America saw a slight increase in subscription revenue but similar to North America licenses and services were down also. Cloud bookings in Asia-Pacific, with total revenues in the region flat year-over-year.Looking at our verticals, our largest deal during the quarter was in the automotive sector and we also had good performance in life sciences. The balance of the business was spread over industrial and food and beverage. Our quality management division performed particularly well with its strongest bookings performance ever combining some strong competitive wins with the existing customer expansion.On the solution side of the business the pipeline of customers working with QAD Adaptive ERP formerly known as Channel Islands continues to build. During the quarter we hosted a large global customer who brought 40 people here to Santa Barbara for a week where they spent testing out our enterprise platform capabilities as low-code/no-code alternative to customizations. The results were very successful with great comments and feedback from our customer who is now working on the medium-term plans for replacing customizations with the platform.During the quarter we also announced an agreement with Ali Baba in China to run QAD in the AliCloud. We believe this strategic partnership forms the foundation on which we can drive significant cloud growth in China. This also represents the first step in our strategy to become a platform agnostic provider giving flexibility to customers to run QAD across a selection of public cloud providers’ offerings.In the QAD labs we continue to invest R&D resources and digital transformation and the application of Advanced Technologies to support efficient and effective manufacturing processes.Of particular interest in this quarter we started work on a project integrating QAD with warehouse automation and robotics. We also worked on a number of used cases related to the application of artificial intelligence and machine learning.I’ll now hand the call over to Pam.

[Pam Lopker:]

Thanks Anton. As Anton mentioned, Q2 was an excellent quarter for QAD and cloud bookings, with 24 new cloud deals and the highest Q2 bookings ever. I was especially pleased to see the Europe region growing back this quarter, with the largest cloud bookings of the quarter. Most of our new customer cloud wins this quarter were against SAP. However, we did see a mixture of different competitors and I will point out them as I highlight a few of our wins.Europe has a large competitive against SAP at a large automotive supplier. The customer did a functional benchmark looking not just at capability but also speed to implement, credibility in the industry and intimacy with the customers during engagement. Our industry knowledge, significantly lower risk factor and customer intimacy were deciding factors on this deal.Another large win against key competitors was for supply chain and quality management solutions for a U.S. headquartered early entrance into the electric truck manufacturing space. A combination of our superior functionality and agility help win this.Three years ago we sold to a start-up med device company. Earlier this year they were purchased by EU headquartered large global life science company with a different ERP strategy. Our proven success at the first expand the fast expanding start up convinced them to go against their legacy strategy and expand the QAD footprint into new site.This quarter we also received the first cloud order from a large multinational U.K. headquartered auto part supplier. With the history of acquisition they have several ERP systems and selected QAD cloud as their corporate standard. Our primary competitor in this deal was Infor and we won due to our superior functionality and dedication to the automotive parts industry.We also had several smaller life science wins this quarter, taking share from a long list of competitors, including Epicor, SYSPRO, NetSuite, SAP and Infor. Our customers told us that selected QAD to -- due to life science experience, supports our regulatory compliance in the cloud and easy to use solutions.Our ability to deliver Adaptive ERP Cloud solutions for our global manufacturing customers enabling their agile business processes at unprecedented level of speed is creating a paradigm shift in manufacturing ERP and I am delighted to say that QAD is leading the way.Thank you. Back to you Anton.

[Anton Chilton:]

Thank you, Pam. So looking forward our investments in sales and marketing are paying off in terms of lead generation and new business acquisition in the cloud. Our lead flow volumes remain ahead of the targets we set for our marketing lead generation teams, our cloud bookings performance is at record levels and our pipeline continues to grow.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 risk remained a factor, including uncertainty facing manufacturers around tariff negotiations and global geopolitics. This has led the slower growth and contraction in some markets and may play a part in future deal cycles. So far though, we haven’t seen a material effect on our pipeline. We don’t expect it to affect our long-term goals.In summary, our sales and marketing efforts are paying dividends, we’re winning business from competitors and we are aggressively driving our cloud business, with substantial market opportunity in front of us, we’re exceptionally well-positioned to meet our long-term objectives.Greg, we’re ready to take questions from analysts.

[Operator:]

Thank you very much, sir. [Operator Instructions] And our first question comes from the line of Bhavan Suri with William Blair. Please go ahead. Your line is open.

[Dylan Carden:]

Hey, guys. This is Dylan on for Bhuvan. I guess, I just kind of wanted to start off, I know you mentioned from macro geopolitical perspective, you’re not seeing any effect in the pipeline. But I was wondering, if there’s anything you’re seeing or hearing like on a vertical specific or a region specific area and that you guys are kind of continually hearing and how does this affect your approach into the second half and further?

[Anton Chilton:]

All right. Thanks, Dylan. So, yeah, as you say, at the macro level, we’re not really seeing any effect and we’re really pleased with the way that the pipeline and funnel is developing actually. And that really translates down to verticals in geo. Well, there’s a mixed picture so we hear about global slowdown in automotive, but subsectors of automotive are actually increasing productions, so electric vehicles, for example.And that seems to be reflective of what’s happening for us is that, that pipeline continues to grow, deals continue to be there. That said, we’re watching very closely as events unfold, but so far we continue to make investments in sales and marketing. They continue to pay off and we’re not expecting any short-term effect based on what we see today.

[Dylan Carden:]

Great. Thank you. Yeah. That’s very helpful. And then, I know you kind of touched on the EMEA side as well, sounds like things are really picking up there, but I guess outside of the new sales hires and then focusing on that pipeline, what kind of types of processes are you guys implementing here to address some of the challenges that you are seen and it sounds that they are leading to kind of starting the pay dividends, I know it’s early in the cycle, but how is this kind of trending versus your expectations?

[Anton Chilton:]

Yeah. So I would say, we -- on the last call we talked about, it might take a few quarters for us to get back where we wanted to be, that’s happening a little bit quicker than we expected, which is really great to see and the funnel is growing significantly there.I think us due to putting in strong management processes, particularly around consistent application of our global sales process, that something we’re doing across the Board right now but that’s been a real emphasis for us in EMEA.We have made some changes in our marketing organization there as well and enhance that. And so we pull all those things together and they are starting to come good. That said, as Daniel said, we still got a little bit more hiring to do and we expect to continue that through this year. And look forward to that pipeline continuing to grow there.

[Dylan Carden:]

Great. Okay. And then, yeah, last one for me, just in reference to that pipeline. Any additional color around, I mean, how subscription heavy as the pipeline looking and then are you guys also currently seeing or -- and expecting to see any kind of change around the deal size or duration of the deals, anything like that? Thank you.

[Anton Chilton:]

Sure. So the quotes I gave on our pipeline and the growth, so, 37% of the same period last year. That’s pure subscription funnel. And so that’s a very strong subscription cloud business pipeline that we have. What’s also pleasing is that we’re seeing an increasing number of very large deals within that and those are both sourced from new customers, as well as conversions.And so we really like the way that that shaping out right now. It’s nicely balanced and we’ve got a good mix of some very large deals with some more modest size deals in there as well. So that gives a little bit more coverage. So, yeah, we really like the way that that’s going.

[Dylan Carden:]

Great. Thank you for taking my questions.

[Daniel Lender:]

Thank you.

[Anton Chilton:]

Thank you, Dylan.

[Operator:]

And next we turn to the line of Zach Cummins with B. Riley FBR. Please go ahead.

[Zach Cummins:]

Hi. Good afternoon. Thanks for taking my questions. So I know it’s been touched on a few times in terms of expected headcount investments in the back half of the year for sales and marketing. Can you provide a little more color around where exactly that headcount investments going more so on quota carrying reps or is it more so on the lead generation side?

[Daniel Lender:]

Sure. Yeah. So we’ve had about 60 heads so far through this year. In the plan right now we’re looking to add about 20 to 30 more. Some of that’s in direct sales executives. Some of that’s in more support role, so kind of business consulting, pre-sales engineers and some marketing roles there.And we think that will continue through this year and we think that will set us up well for our growth plans as we head into FY ‘21. That doesn’t mean we’ll stop hiring, but the rate at which we do that’s likely to slow down as we head towards the back end of this year.

[Zach Cummins:]

Understood. That’s helpful. And then in terms of the Professional Services Group, it sounds like many of your customers are now electing to convert over to the cloud before taking on any sort of large Professional Services engagement. Over the longer term, should we expect a bigger portion of Professional Services revenue will continue to shift over to partners or how should we think about the longer-term Professional Services business?

[Anton Chilton:]

Absolutely. So we’ve been thinking for a while and had a strategy of moving and growing our ecosystem and moving more of that business to partners. The rate at which customers are electing to move into this cloud first and then do the upgrade has caused us to accelerate our strategy or advance it.So, yeah, you should expect to see the services business come down as a proportion of the overall revenue of QAD, but it will continue to grow as we grow, of course, but you’ll see more of our partners contributing to that over time.

[Zach Cummins:]

Understood. And then in terms of the really strong cloud bookings in the first half of the year and it sounds like there’s still plenty of opportunity out there at this point in the funnel. Can you talk about your confidence level in reaccelerating that subscription revenue towards your longer-term 30% target?

[Anton Chilton:]

Absolutely. We are very confident of that right now. We just look at the way that the funnel unfolded in -- particularly in the second quarter there and the record performance we’ve had, as I said earlier, when we look at the balance of deals that we have in the funnel and prospects, that’s a really healthy mix of new customers taking market share from competitors and conversion of existing customers and further expansion in those customers too. So we really feel good. All things being equal, that we are well placed to hit those long-term targets as we get towards the end of this year.

[Zach Cummins:]

Understood. And just one question for Daniel. In terms of the subscription margin for the quarter, it was down on a sequential basis. Can you talk about the driver for that lower subscription margin in this quarter?

[Daniel Lender:]

Yeah. So there is -- with the -- some of the acceleration in deals that we are seeing, there are some investments that we need to do up from an infrastructure standpoint that sometimes from a timing perspective get ahead of the revenue component. So that has a bit of an effect there. We don’t expect the Alibaba cloud to have a very material effect in the short-term but that puts just a little bit of pressure there as well as it’s a brand new center for us.

[Zach Cummins:]

Understood. That’s helpful. Well, thanks again for taking my questions and best of luck in the second half of this year.

[Anton Chilton:]

Thank you, Zach.

[Daniel Lender:]

Thanks.

[Operator:]

[Operator Instructions] And our next question comes from the line of Ishfaque Faruk with Sidoti and Company. Please go ahead.

[Ishfaque Faruk:]

Hi, guys. Good afternoon. Thanks for taking my question. Daniel, you briefly touched on this in the last caller. On the Alibaba deal side, can you explain what the long-term consequences of using AliCloud for your QAD China Services?

[Daniel Lender:]

Hi, Ishfaque. If it’s all right with you, I’ll jump in and answer that.

[Ishfaque Faruk:]

All right.

[Daniel Lender:]

So there’s couple of strands to that. First from a China perspective, we really expect that to be a significant boost to our capability to grow our cloud business there, particularly with our Chinese headquartered or local companies there.There’s a lot of sensitivity of hosting data outside of China and so having trusted name like Alibaba or Chinese company like Alibaba there, where the data will be stored. I think is significant opportunity for us, and of course, they are very well-known and very well trusted in that market too. So that’s great.The other kind of strategic strength for that for us on a global basis is that this is really our first step as we look to become, as I said earlier, platform agnostic. We’re driving to a point where QAD application would be available across selected providers cloud platform. And that could -- those choice -- customers are going to make a choice based on economics or maybe some of the technologies and add-ons that some of those cloud providers have, so this is really the first step in that journey of proving that out.

[Ishfaque Faruk:]

Okay. And -- I am sorry…

[Pam Lopker:]

I will just add to that.

[Ishfaque Faruk:]

Go ahead.

[Pam Lopker:]

I will just add to that. We use a tool to kind of extract out the difference between different cloud provider environment, so that we’re doing everything the same regardless of what cloud environment is working on. So we don’t believe we’ll have increase costs entering the service cloud environment, but we do think the ability to do that is really important to our customers particularly on -- in regions like China.

[Ishfaque Faruk:]

Okay. And in terms of your cloud funnel, you guys mentioned that it was one of the record for the first half of the year in terms of cloud funnel and bookings. Could you give me a sense for like where do you see it growing in the long-term because considering you guys trimmed your guidance for the rest of the year slightly?

[Anton Chilton:]

Yeah. Sure. So the trimming and adjustment is really based on timing effect of, so whilst we had record bookings in the first half, that was more skewed towards Q2. We had -- we were a little bit lower against you internal targets on Q1. And so really that timing effect is what causing the adjustment for this year.As I said earlier that, we think for the long-term and our goals is still to push that 30% year-on-year growth in subscription. You see that we’ll be kind of at the run rate of that by the end of this year and that will flow through into next year.

[Ishfaque Faruk:]

All right. Thank you so much.

[Anton Chilton:]

You’re welcome.

[Daniel Lender:]

Thank you, Ishfaque.

[Operator:]

And next we turn to line of Adam Borg with Stifel. Please go ahead.

[Adam Borg:]

Great and thanks for taking the question. Really nice to hear about the list of competitive wins and was just -- maybe you could dig a little deeper into what are the key products or even marketing messages that are helping to become so much competitive against the broad list you mentioned? Thanks.

[Anton Chilton:]

Yeah.

[Pam Lopker:]

Yeah. I think that really our move to our Adaptive ERP platform has really helped our wins customers love, the new user interface, the ability to have a low no-code environment, the extreme simplification for their companies and for IT resources, so it’s been just very, very exciting time, our customers are thrilled about it and so are we.

[Anton Chilton:]

Absolutely.

[Adam Borg:]

Great. Thanks so much.

[Pam Lopker:]

Thanks.

[Anton Chilton:]

Thanks, Adam.

[Operator:]

And we’ll now turn the call back to Anton for closing remarks.

[Anton Chilton:]

All right. Thank you, Greg. So thank you everyone for joining today’s call. We look forward to updating you in November on our third quarter results. Thank you very much.

[Operator:]

And ladies and gentlemen this conference will be made available for replay after 4 p.m. today until August 28, 2019, at midnight. You may access the AT&T executive playback service at any time by dialing 1-800-475-6701 and entering the access code 470288. International participants may dial 1-320-365-3844. Again those numbers are 1-800-475-6701 and entering the access code 470288. International participants may dial 1-320-365-3844 and enter that same access code of 470288. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.